TCRP

Transit Cooperative Research Program

Sponsored by the Federal Transit Administration

LEGAL RESEARCH DIGEST

August 1999--Number 13

________________________________________________________________________________________________________

Subject Areas: IA Planning and Administration, IC Transportation Law, VI Public Transit

Report on Innovative Financing Techniques for Transit Agencies

This report was prepared under TCRP Project J-5, "Legal Aspects of Transit and Intermodal Transportation

Programs, "for which the Transportation Research Board is the agency coordinating the research The report was

prepared by Mary A Collins James B McDaniel, TRB Counsel for Legal Research Projects, was the principal

investigator and content editor

THE PROBLEM AND ITS SOLUTION

The nation's transit agencies need to have access

to a program that can provide authoritatively

researched, specific, limited-scope studies of legal

issues and problems having national significance and

application to their businesses The TCRP Project J-5

is designed to provide insight into the operating

practices and legal elements of specific problems in

transportation agencies.

The intermodal approach to surface

transportation requires a partnership between transit

and other transportation modes. To make the

partnership work well, attorneys for each mode need

to be familiar with the legal framework and processes

of the other modes. Research studies in areas of

common concern will be needed to determine what

adaptations are necessary to carry on successful

intermodal programs

Transit attorneys have noted that they

particularly need information in several areas of

transportation law, including

· Environmental standards and requirements;

· Construction and procurement contract

procedures and administration;

· Civil rights and labor standards; and

· T ort liability, risk management, and system

safety

In other areas of the law, transit programs may

involve legal problems and issues that are not shared

with other modes; as, for example, compliance with

transitequipment and operations guidelines, FTA

financing initiatives, private-sector programs, and

labor or environmental standards relating to transit

operations Emphasis is placed on research of current

importance and applicability to transit and intermodal

operations and programs.

APPLICATIONS

Transit agencies now have an enormous need for

equipment and facilities, and the resources available

from federal, state, and local governments cannot

keep up with their capital needs. Transit agencies can

no longer rely solely on funding from federal, state,

and local governments, but must find optional

methods to raise capital and increase cash flow These

agencies are under pressure to use "innovative

financing techniques" to meet that need

This publication explores the nature of

"innovative financing techniques" and describes

situations in which such techniques have been used It

should be useful to transit administrators, attorneys,

debt managers, capital programs managers,

comptrollers, financial officers, planners, and project

development officials.

____________________________

TRANSPORTATION RESEARCH BOARD

NATIONAL RESEARCH COUNCIL
CONTENTS

I--Introduction.................................................................................................................................................................... 5

II--Certificates of Participation Involving FTA 49 U.S.C. § 5307 ("Section 9") Funds .......................................................... 5

Introduction ................................................................................................................................................................ 5

The Structure of a Certificates of Participation Transaction .......................................................................................... 6

FTA Section 9 Funding............................................................................................................................................... 6

Case Study--Sacramento Regional Transit District $32.44 Million California Transit Finance Corporation

Certificates of Participation, 1992 Series A.................................................................................................................. 8

The Parties.......................................................................................................................................................... 8

The Project.......................................................................................................................................................... 8

The Financing ..................................................................................................................................................... 8

Case Study--$9.66 Million California Transit Finance Corporation Certificates of Participation, 1996 Series A (City

of Culver City, California) .......................................................................................................................................... 9

The Parties.......................................................................................................................................................... 9

The Project.......................................................................................................................................................... 9

The Financing ................................................................................................................................................... 10

III--Joint Development ..................................................................................................................................................... 11

Introduction .............................................................................................................................................................. 11

The Structure of a Joint Development Transaction ..................................................................................................... 11

Legal and Policy Authority for Joint Development ............................................................................................. 11

Private Use Issues ............................................................................................................................................. 12

Case Study--Vertical Mall Joint Development for Miami-Dade Transit Agency (Dade County, Florida)...................... 12

The Parties........................................................................................................................................................ 12

The Project........................................................................................................................................................ 13

The Financing ................................................................................................................................................... 13

Case Study--Santa Clara Valley Transportation Agency--Almaden Lake Village ........................................................ 13

The Parties........................................................................................................................................................ 13

The Project........................................................................................................................................................ 13

The Financing ................................................................................................................................................... 14

Case Study--San Francisco Bay Area Rapid Transit District (BART) Telecommunications System ............................. 15

The Parties........................................................................................................................................................ 15

The Project........................................................................................................................................................ 15

The Financing ................................................................................................................................................... 15

Lessons Learned from Joint Development.......................................................................................................... 16

IV--Cross-Border Leases of Transit Vehicles .................................................................................................................... 16

Introduction .............................................................................................................................................................. 16

The Structure of a Cross-Border Lease Transaction.................................................................................................... 16

Risks To Lessees............................................................................................................................................... 17

Case Study--Regional Transportation District (Denver, Colorado) Cross-Border Lease ............................................... 19

The Parties........................................................................................................................................................ 19

The Project........................................................................................................................................................ 19

The Financing ................................................................................................................................................... 19

Case Study--San Diego Metropolitan Transit Development Board Cross-Border Lease Financing ............................... 19

The Parties........................................................................................................................................................ 19

The Financing ................................................................................................................................................... 21

Innovative Nature of the Financing .................................................................................................................... 21

Asset Swap for Defeasance................................................................................................................................ 21

V--U S. Leasehold Interest................................................................................................................................................ 22

The Structure of U.S. Leasehold Interest Transactions................................................................................................ 22

Selected Indicative Issues.......................................................................................................................................... 26

Case Studies............................................................................................................................................................. 26
VI--Fare Box Revenue Bonds........................................................................................................................................... 26

Introduction .............................................................................................................................................................. 26

The Structure of a Fare Box Revenue Transaction...................................................................................................... 26

Case Study--New York Metropolitan Transportation Authority Transit Facility Revenue Bonds, Series 1998C........... 27

The Parties........................................................................................................................................................ 27

The Project........................................................................................................................................................ 27

The Financing ................................................................................................................................................... 27

Case Study--$169.5 Million Los Angeles County Metropolitan Transportation Authority General Revenue Bonds

(Union Station Gateway Project) Series 1995-A......................................................................................................... 29

The Parties........................................................................................................................................................ 29

The Project........................................................................................................................................................ 29

The Financing ................................................................................................................................................... 29

Postscript.................................................................................................................................................................. 31

VII--State Revolving Loan Funds/State Infrastructure Banks............................................................................................. 31

Introduction .............................................................................................................................................................. 31

The Structure of a State Infrastructure Bank Transaction............................................................................................ 31

VIII--Conclusion.............................................................................................................................................................. 32

Appendix A--Listing of Agencies Involved in Case Study Transactions ............................................................................. 34

Appendix B--Innovative Financing Techniques-Transportation Research Board Questionnaire/Results............................... 35
This page left intentionally blank.
5

REPORT ON INNOVATIVE FINANCING TECHNIQUES FOR TRANSIT AGENCIES

By Mary A. Collins, Orrick, Herrington & Sutcliffe LLP, San Francisco, California

I--INTRODUCTION

For over a decade, transit agencies across the United

States have been faced with the challenge of finding or

maintaining revenues with which to meet their growing

budgets for operations and capital costs relating to

providing transit services to their constituents. In California

alone, the Californians for Better Transportation estimates

that the unfunded annual needs of public transit total over

half a billion dollars. The traditional sources of funding for

transit providers have been state and federal grants and fare

box revenues, but due to budget restraints, both federal and

state governments have been reluctant to continue the level

of subsidies for transit that have been pervasive in the past.

Recognizing this, the federal government has been

encouraging new sources of revenue and innovative

applications of existing revenues to support transit services.

The Intermodal Service Transportation Efficiency Act of

1991 (ISTEA) encouraged revenue enhancement and more

efficient management of public transit infrastructure

through the creation of public/private partnerships.

On May 9, 1995, the Federal Transit Administration

(FTA) published a notice regarding its innovative financing

initiative in the Federal Register (60 Fed. Reg. 24682), in

which FTA described innovative financing methods and

asset management tools that may be used in connection

with projects receiving assistance from the FTA in order to

facilitate financing; leverage federal, state, and local funds;

and otherwise increase the effectiveness of transit capital

projects.

Using the FTA notice as a guide to the types of

innovative financing methods in use, we conducted a

survey to gather case studies of such techniques in

operation. In March 1996 a questionnaire was mailed to

400 transit providers requesting them to identify innovative

financing techniques they had used. Responses were

received from 97 transit agencies, although many of those

responding simply requested copies of the finished report.

After reviewing the results of the survey, we contacted

various transit agencies to attempt to determine appropriate

case studies. For each financing technique we identified at

least one or two agencies from which we could obtain the

necessary information for a study. In discussions with

agencies we sometimes identified appropriate case studies

that were not initially identified in the survey response,

such as examples of joint development.

This report describes the identified techniques that

have been successfully employed or attempted by transit

operators in order to increase revenues available for transit

capital or operating needs or to provide development of

transit assets in innovative ways. Learning by example is

often the easiest way to learn and by

studying the case studies set forth in this report, transit

operators across the country can duplicate these techniques

or expand on them with their own innovative financing

techniques to produce revenues or transit assets for the

commuting public.

Certain legal issues are raised with respect to any

innovative financing technique that is employed. First, one

has to examine any federal regulations or issues that are

raised by using federally-funded assets in an innovative

financing technique. FTA's policy of encouraging financing

innovations has not necessarily trickled down to the

regulations governing the use of federallyfunded assets.

Amendments to regulations or special consents are often

required. State laws must also be examined to determine

whether the innovative financing technique runs afoul of

state law prohibitions. Where there are public/private

partnerships or the use of public assets by private entities,

state laws may restrict such participation by private firms.

Finally, federal tax law issues may be raised if tax-exempt

financing has been involved in any of the assets under

consideration for the financing technique. Tax-exempt

financing also places limits on the private use of projects

funded with tax-exempt funds. This report describes case

studies where financings have been undertaken.

The case studies that we present here involve the

following areas:

1. Certificates of participation or lease financing of transit

assets,

2. Joint development,

3. Cross-border leasing,

4. U.S. leverage leases,

5. Fare box revenue bonds, and

6. State revolving loan funds.

Appendix A to this report contains addresses for the

public entities involved in the case studies and identifies

the counsel or other officer of the transit agencies familiar

with the financing studied.

II--CERTIFICATES OF PARTICIPATION

INVOLVING FTA 49 U.S.C. § 5307 ("SECTION 9")

FUNDS

Introduction

One promising innovative financing technique for

transit projects is the use of FTA Section 9 funds to

subsidize principal and interest payments with respect to

Certificates of Participation (COPs).1

 This chapter

_____________________________________

1

 On July 5, 1994, Public Law No 103-272 passed and

codified federal transit laws under Chapter 53 of the United States

Code. The law repealed the Federal Transit Act without

substantive change. The original meanings of the Federal Transit

Act provisions are unchanged even though the new language in

some instances differs from that of the original
6

will include a general discussion of COPs and the use of

FTA Section 9 funds to help finance the acquisition of

transit-related capital projects through the sale of COPs

The Structure of a Certificates of Participation

Transaction

COPs are securities that represent interests in a stream

of payments from an underlying obligation, typically a

lease or an installment sale agreement. The governmental

entity's payments pursuant to this underlying obligation are

assigned to a trustee who pays such moneys to the holders

of the COPs. For transit finance purposes, this underlying

obligation is usually a lease, since FTA Section 9 funds are

available to pay a portion of such lease payments, as

discussed below.

COPs in lease payments are a mechanism for

governmental entities to finance capital projects without

technically issuing long-term debt. The issuance of longterm debt is commonly subject to voter approval and other

State constitutional and statutory requirements. Case law in

various jurisdictions supports the proposition that leases do

not constitute "debt" for these purposes because the

governmental lessee is not obligated at the outset to make

rental payments throughout the entire term of the lease, but

is only required to pay rent each year to the extent the

leased property is available for use during such year.2

In a typical COPs financing:

• An item of real or personal property with adequate

annual fair rental value and useful life is identified as the

asset to be subject to the Financing Lease. Such leased

asset may be the property to be acquired or constructed

with the proceeds of the COPs, in which case interest with

respect to the COPs will need to be capitalized until the

acquisition or construction of the property is complete.

Alternatively, in an "asset transfer" or "asset strip"

structure, such leased asset may be a preexisting item of

property, which obviates the need for capitalized interest

• The identified item of property is leased to a second

party (often for nominal consideration), which becomes the

lessor entity under the Financing Lease.

• The property is then leased back to the

governmental entity pursuant to a Financing Lease for rent

that approximates the fair rental value of the property.

These rent payments have designated principal and interest

components that equal the principal and interest

represented by the COPs. In addition to specifying the

rental obligation, the Financing Lease typically calls for

abatement of rent if the leased asset is damaged, destroyed,

taken by eminent domain, or (for real property) subject to

title defect. The Financing Lease also includes covenants to

maintain insurance and

______________________________________________________

Act Section 5307 of Title 49 of the U S C replaced Section 9 of the

Federal Transit Act, but the funds are still called "Section 9" funds

in common parlance and are so called in this report. 2

 See Rider v City of San Diego, 18 Cal. 4th 1035, 959 P 2d

347 (Cal 1998)

specifies remedies for the failure to make rent payments.

The right to receive rent payments and to exercise remedies

under the Financing Lease is typically assigned to a trustee

acting on behalf of the holders of the COPs.

• COPs are sold as securities to investors in both

private placements and public offerings. The credit strength

of COPs may be enhanced with bond insurance, letters of

credit, or other guarantees. Because of the risks of

abatement and nonappropriation of lease payments, an

issuer's COPs are generally considered less creditworthy

than its general obligation debt.

FTA Section 9 Funding

The link between FTA Section 9 funding and

payments on COPs begins with Section 308 of the Surface

Transportation and Uniform Relocation Assistance Act of

1987 (STURRA).3 Section 308 authorized the use of

Section 9 federal transit funds for leases of facilities and

equipment at the 80 percent matching level in projects

where leasing is determined to be more cost effective than

purchase or direct construction. Previously, the interest

portion of lease payments was treated as an operating

expense and eligible for reimbursement at only a 50 percent

matching ratio.

The FTA issued a Final Rule on Capital Leases to

clarify the application of Section 308 on October 15, 1991.4

The primary change reflected in the FTA's 1991 Capital

Leasing guidelines is the ability to treat lease payments,

including interest costs, as capital expenses eligible for

reimbursement at the full, 80 percent federal matching

level. Since COPs represent an interest in a stream of

payments, including lease payments, the new FTA policy

created a clear opportunity for transit agencies to use

federal moneys in support of long-term financings.

The FTA's guidelines allow any asset eligible as a

capital item to be leased. Moreover, the Department of

Transportation's comments accompanying the rules state

that the Senate Report language for Section 308 of

STURRA envisioned application of federal transit leasing

for such items as "computers, maintenance of way and

other heavy equipment, maintenance of effort rail

equipment, radio equipment, bus garages, property or

structures for park and ride, and other buildings or facilities

used for mass transit purposes."5 Despite the variety of

assets that may be leased, the typical FTA Section 9

supported COP has involved the acquisition of buses. The

use of this financing mechanism versus a pay-as-you-go

policy allows transit agencies (either separately or in a

pooled transaction) to make larger purchases of bus assets

sooner, thereby enhancing service.

Since FTA Section 9 funding is subject to

congressional appropriation each year, there is no guarantee

_____________________________________

3

 Pub L No. 100-17 § 308 (April 2, 1987) 101 Stat 226.

4

 49 C F R Part 639.

5 See 56 Fed Reg. 51786 (Oct 15, 1991)
7

that sufficient funds will always be available to pay the full

80 percent match of lease payments. Thus, rating agencies

and capital market participants do not treat Section 9 funds

as a guarantee, and the focus of any credit analysis is still

on nonfederal revenues.6 Moreover, the FTA's capital

leasing guidelines impose a financial capacity test that

requires that the lessee transit agency certify that it has the

ability to meet future lease obligations in the absence of

federal funding.

The FTA also requires that a determination of cost

effectiveness be made in order to justify a lease structure

instead of a traditional pay-as-you-go purchase

arrangement The calculation is made by the grantee

using the guidance set forth in FTA's Final Rule on Capital

Leases and involves a self-certified net present value

analysis of costs and benefits. The most common rationale

for lease financing over a pay-as-you-go program is

avoiding the cost inflation inherent with later purchases, as

well as the economics of scale afforded by larger, one-time

purchases.

Key Legal Issue: Under state law, the threshold legal

issue is whether the lease or COP structure is permitted,

without voter approval, under constitutional and statutory

provisions. The key legal issue for FTA approval is the cost

benefit analysis of the financing.

_____________________________________

6

 JEFFREY A PARKER, How TO EVALUATE

OPPORTUNITIES FOR CROSS BORDER LEASING AND

CERTIFICATES OF PARTICIPATION 78 (1993)
8

Case Study--Sacramento Regional Transit District

$32.44 Million California Transit Finance Corporation

Certificates of Participation, 1992 Series A

In the spring of 1992, the Sacramento Regional

Transit District of Sacramento, California, participated in

the sale of $32.44 million COPs to finance the acquisition

of approximately 75 buses, a fare collection system, and a

radio system The COPs represented proportionate interests

in the lease payments to be made by the District to the

California Transit Finance Corporation (CTFC), a nonprofit

corporation, for lease of the project. One of the sources of

revenue supporting the District's lease payments is a FTA

Section 9 capital grant.

The Parties

The Sacramento Regional Transit District is a

legislatively created transit district that encompasses an

area of 340 square miles, including the City of Sacramento

and most of the urbanized area within Sacramento County.

The City of Sacramento is the state capital of California

located approximately 75 miles northeast of San Francisco

The County of Sacramento has a population of over 1

million, approximately onethird of which live within the

City of Sacramento. The District operates a fleet of 200

buses and an 18.3-mile light rail line.

CTFC is a nonprofit public benefit corporation

created in 1990 by the California Transit Association to

provide financing assistance to California transit entities.

CTFC provides transit agencies with standardized lease

financing documents for stand-alone and pooled COPs

supported in part by FTA Section 9 capital grants The

CTFC structure has been market tested by the major rating

agencies as well as the public finance capital markets.

Typically, CTFC transactions involve a preestablished

financing team of financial advisors, bond counsel,

underwriter, and underwriter's counsel. To date, CTFC has

participated in at least six successful COP financings

involving FTA Section 9 funds.

The Project

The project included three components: (1) Purchasing

75 heavy-duty transit buses, (2) Installing a fare collection

system, and (3) Installing a new radio system The buses are

approximately 40 feet long by 102 inches wide, equipped

with natural gas engines, air conditioning, and front and

rear doors with a wheelchair lift at the front door. Delivery

of the buses was anticipated to take place over a period of

16 to 22 months. Cost of the buses was estimated at $21.5

million, which included acquisition and delivery costs.

The new fare collection system was for the District's

bus fleet (now 200 buses). The fare collection system

consisted of 200 registering fare boxes plus cash boxes,

five receiver vaults, and a data collection system to record

cash received onboard the buses. The onboard registration

feature aids the drivers in determining whether proper fare

has been received and also provides

information that can be used to reconcile and audit cash

receipts. The cost was estimated at $2.0 million.

The radio system replaced an aging 14-year-old, threechannel system that was experiencing frequent breakdowns

and gaps in geographical coverage. The new system was to

be a six-channel "trunk" radio system providing the

necessary flexibility for bus, rail, and paratransit services

over the next 12 years. The equipment procured consisted

of three base stations, 300 mobile units, and a number of

hand-held portable radios. The cost was estimated at $4.0

million.

The Financing

As indicated in the Official Statement dated April 8,

1992, proceeds of the Certificates were allocated as

follows:

Acquisition Fund (1) $25,194,696

Lease Payment Fund (2) 3,231,382

Reserve Fund (3) 3,213,601

Financing Fee (4) 496,332

Original Issue Discount 303,939

Total Principal Amount of Certificates $32,440,000

(1) Includes Delivery Costs

(2) All of the interest accrued with respect to the

Certificates from the date of execution and

delivery of the Certificates through December 1,

1993, and a portion of the interest due on the

Certificates from January 1, 1994 through April

1, 1994, was capitalized.

(3) Equal to 10% of principal amount of the

Certificates, less original issue discount

(4) Includes Underwriter's discount and certain

costs of issuance associated with the execution

and delivery of the Certificates

The Lease Payment Fund was funded with COP

proceeds sufficient to make all lease payments due prior to

the expected completion date of the project.

Each Certificate represents a proportionate interest in

the lease payments to be made by the District to the

Corporation under the financing lease. The Corporation,

pursuant to an assignment agreement, assigned its rights

and remedies under the Lease Agreement (except certain

rights to indemnity and reimbursement of expenses) to the

trustee bank for the benefit of the owners of the

Certificates, including its right to receive lease payments.

Principal and interest due with respect to the Certificates is

made from the lease payments payable by the District;

insurance or condemnation proceeds pertaining to the

project, to the extent that such proceeds are not used for

repair or replacement; and interest or other income derived

from the investment of the funds and accounts by the

Trustee pursuant to the Trust Agreement. Lease payments

are paid from revenues of the District.

The District applied for a Letter of No Prejudice from

FTA, pursuant to ISTEA, for the reimbursement of a

portion of the capital costs of acquiring the project. Prior to

the closing of the financing, the District received a

notification from FTA indicating FTA's preliminary
9

approval (subject to final review of legal documents) for

the annual reimbursement to the District of 80 percent of

the lease payments net of capitalized interest and the

earnings on the reserve fund (the "Net Lease Payments").

The District included the following disclosure in its

official statement for the financing:

Although ISTEA provides federal funding for

transportation purposes through the federal government's

fiscal year ending September 30, 1997, receipt of

funding by the District for any fiscal year beyond the

current federal fiscal year is subject to future

Congressional appropriation for transit purposes and

future submittal of grant applications by the District with

the FTA Receipt of funding by the District for any

federal fiscal year beyond the federal fiscal year ending

September 30, 1997 is subject to future Congressional

authorization Furthermore, although ISTEA establishes

the federal matching ratios for transit projects at 80%, no

assurances can be made that the funding level for the

FTA Project Grants at 80% of Net Lease Payments

expected to be preliminarily approved by FTA under

Section 9 for the FT Act (as hereinafter defined) will be

continued in any future Congressional authorization

The District expects to fund the remaining portion of

Lease Payments which are not funded with the FTA

Project Grants from Revenues, which include State and

local funds and other legally available sources.

Due to the contingent nature of the federal grants,

rating agencies rely on the ability of the District to make

lease payments from other revenue sources in assigning a

credit rating to the transaction. The District receives

portions of the local sales tax and gas tax moneys levied

pursuant to state law and a local sales tax initiative. This

revenue, which is independent of fare box revenue, is used

for the local match for the FTA grants. For this issue the

District was assigned a rating of A-1 by Moody's Investors

Service.

The lease payments were structured with equal

principal payments of approximately $2,705,000 each year,

resulting in a declining annual payment in order to

approximate the depreciating value of the buses and to

protect investors from a possible change in FTA funding.

The issuance of the COPs enabled the District to

receive a favorable bid on a large bus order, resulting in

more capital assets for less expenditure of funds. Economy

of scale was also realized in the low issuance costs

allocable to the remaining portions of the project.

The key legal issue as to what authority existed under

state law to enter into the lease was determined by the

District's special counsel. The FTA's approval or letter of

no prejudice was the key factor in allowing the District to

determine to proceed with the financing. The role of

Agency counsel, as is true for most innovative financing

techniques, is to render opinions that the Agency has the

authority to engage in the transaction and to ensure that the

proper procedural steps for the adoption of the required

Agency resolutions have been followed by the Agency.

Special counsel is customarily engaged to provide opinions

to the investors in the

COPs or to the counterparties involved in other innovative

financing transactions.

Case Study-$9.66 Million California Transit Finance

Corporation Certificates of Participation, 1996 Series A

(City of Culver City, California)

On June 4, 1996, the City of Culver City, California

and the CTFC participated in the sale of $9.66 million

aggregate principal amount of COPs to finance a portion of

the construction costs relating to the city's Transportation

Administration/Maintenance facility. One of the sources of

revenue supporting the Certificates is FTA Section 9 capital

grants. This transaction involved a number of significant

innovations, which are discussed in more detail below.

The Parties

The City of Culver City, California, is located about 8

miles west of downtown Los Angeles and 2 miles north of

the Los Angeles International Airport, encompassing an

area of almost 5 square miles. In 1994 the city had a

population of approximately 38,793. The city operates the

Culver City Municipal Bus Lines (CCMBL), the second

oldest municipally owned bus agency in the State of

California. CCMBL maintains a fleet of 33 buses, of which

30 are used in regular service.

The CTFC is a nonprofit public benefit corporation

created in 1990 by the California Transit Association to

provide financing assistance to California transit entities.

CTFC provides transit agencies with standardized lease

financing documents for stand-alone and pooled COPs

supported in part by FTA Section 9 capital grants. The

CTFC structure has been market tested by the major rating

agencies as well as the public finance capital markets.

Typically, CTFC transactions involve a preestablished

financing team of financial advisors, bond counsel,

underwriter, and underwriter's counsel. To date, CTFC has

participated in at least five successful COP financings

involving FTA Section 9 funds.

The Project

Prior to the financing, CCMBL provided bus

maintenance services on a crowded 3.96-acre City Yard

site shared with the city's Public Works, Parks

Maintenance, and Purchasing Divisions. In order to provide

more efficient and cost-effective service, CCMBL

proposed a plan to the FTA that included (i) dedicating the

entire City Yard site for public transit purposes, (ii)

demolishing existing buildings and constructing a new

parking structure and transit facility, including an

administrative/maintenance building containing a fueling

island, bus washer, eight bus bays, inspection area, and a

welding shop, and (iii) purchasing a new site and

remodeling an existing building to accommodate the

displaced city divisions. The project described above would

allow CCMBL to increase its bus fleet from 33 to 60 in

anticipation of increased demand for public transit service.

The FTA accepted and approved CCMBL's proposal
10

through their adoption of a Federal Highway

Administration rule referred to as "functional replacement."

The total cost of the project was estimated at $23.8

million Certificate proceeds provided approximately $8.4

million, with the balance of the cost being paid by city

contributions and FTA Section 9 capital grants (in addition

to the Section 9 funds expected to pay debt service on the

Certificates).

The Financing

The CTFC Certificates represent a proportionate

interest in lease payments made by the city to CTFC under

a lease agreement between the city and CTFC. CTFC

assigned these lease payments to the trustee for the

Certificates, as well as any insurance or condemnation

proceeds relating to the property encumbered by the Lease

Agreement, to the extent not required for the repair or

replacement of such property. Payments under the Lease

Agreement are payable only from "revenues" of the city,

which are defined as (i) certain FTA Section 9 capital grant

funds, (ii) the Local Transportation Fund portion of

California Transportation Development Act funds, (iii) the

city's share of State Transit Assistance Funds and (iv) the

city's discretionary and local return portion of two 1/2 cent

transportation sales taxes levied in Los Angeles County.

General fund moneys of the city are not included in the

definition of "revenues" and are therefore not available to

make payments under the Lease Agreement. The Lease

Agreement provides that the obligation of the city to make

payments under the Lease Agreement solely from revenues

is unconditional and not subject to abatement in the event

of a casualty loss involving the leased facilities.

The Certificates are also secured by a reserve fund

held by the trustee, funded at maximum annual debt service

on the Certificates. Finally, the payment of principal and

interest with respect to the Certificates is guaranteed by a

municipal bond insurance policy issued by AMBAC

Indemnity Corporation.

The Certificates represent a clear progression in the

manner FTA Section 9 supported COPs have been

structured The primary innovation is the use of real

property instead of buses to serve as the asset encumbered

by the Lease Agreement. This produces several financial

benefits to the city. Since the city's Transportation

Administration/Maintenance facility has a longer useful life

than vehicles, the city was able to spread out its payments

over a 20-year term, as opposed to the 12year term usually

seen in bus financings. In addition, there will be sufficient

rental value in the project to allow for level debt service

instead of the declining payments that are associated with

bus leases, again maximizing the benefits of tax-exempt

financing.

FTA permitted the use of Section 9 capital grant

moneys to support the financing costs of the project

because the city's Transportation

Administration/Maintenance facility is clearly transitrelated. In

addition, FTA allowed Section 9 funds to account for 100

percent of debt service on the Certificates, as opposed to

the traditional 80 percent match. The rationale for this

arrangement is that the city contributed approximately $3.9

million of land upon which the project will be located and

further contributed $3.1 million in cash to finance the

project. These up-front contributions satisfied the FTA's

requirement of a 20 percent local match for FTA Section 9

projects.

Another innovative feature of the Certificates involves

the lack of capitalized interest. Typically, the FTA requires

interest payments on Section 9 lease financings to be

capitalized for a period sufficient to allow the construction

or acquisition of the asset encumbered by the lease. Until

the asset is ready for use and occupancy, FTA Section 9

capital grants may not be used to pay debt service. This

policy mirrors the practice of most bond counsel firms in

California, which generally require capitalized interest

prior to the construction or acquisition of the leased asset so

that the initial lease payments will not violate the debt limit

embodied in Article XVI, Section 18 of the California

Constitution. The need to capitalize interest increases the

amount of COPs required to be sold and increases the total

debt service obligation of the governmental lessee.

Since the relevant lease payments consist of special

revenues not subject to the State Constitutional debt limit,

FTA policy for this transaction mirrored State law in this

regard and permitted FTA Section 9 supported lease

payments to be made prior to the completion of the city's

Transportation Administration/Maintenance facility.

Another unique aspect of this transaction is the use of

a bond insurance policy to enhance the rating of the

Certificates to AAA/Aaa by Standard & Poor's Ratings

Services and Moody's Investors Service, respectively. The

premium for this bond insurance was less than the net

present value of the marginally higher interest that would

have been payable on an unenhanced issue. This is

apparently the first new issue FTA Section 9 supported

COP to have been enhanced by bond insurance.

The use of bond insurance and real property as the

leased asset represents a logical extension of the COP

structure inherent in these financings. So long as a

governmental entity can demonstrate to the FTA a

sufficient transit purpose, further financings can reflect

various permutations, including "asset transfer" or "asset

strip" structures, variable rate COPs backed by liquidity

facilities, and other complex arrangements that are now

commonplace for non-FTA supported COPs.

Bond counsel (or special counsel as they are

sometimes described in COP financings) delivered the

customary legal opinion in this transaction that the Lease

Agreement was a valid and binding obligation of the city.

Such opinion is customarily required on all publicly sold

COP financings by an independent bond counsel firm.

Bond counsel makes this determination based on case law

or may require the issuing entity to file a
11

validation action or some other similar court proceeding to

determine the validity of the transaction prior to proceeding

with the transaction.

The authority for lease financing is very well

developed in California.7 In other jurisdictions, case law

authority may not be as developed and in considering any

lease financing, the threshold legal issues are whether there

is authority to enter into the lease financing and whether

there is any constitutional impediment to the lease

transaction.

III--JOINT DEVELOPMENT

Introduction

Another promising method of innovative financing for

transit projects is joint development projects. This chapter

will include a discussion of joint development and the

issues it raises.

The Structure of a Joint Development Transaction

Joint development involves a partnership or joint

venture between a transit agency and a private developer to

develop certain assets It can also mean a relationship

whereby the transit agency receives revenues or transit

facilities and the developer receives use of either real estate

or some other asset owned by the transit agency. Joint

development is seen as a method by which private funds

are used to develop transit property resulting in profit for

the private developer and a developed asset for the transit

agency. Risks related to the development are either shared

or borne by the transit agency or the private developer.

One of the chief assets that transit agencies commonly

have that can be made available for development by a

private developer is real estate. An example is where a

transit agency has a surface park-and-ride lot and in

exchange for a portion of the lot, the developer will agree

to construct a parking structure on the remaining surface

parking area. The increased development may mean greater

residential density or commercial activity next to the transit

facility, leading to increased ridership. Although real estate

is the most common asset that a transit agency uses in order

to participate in a joint development project, the right-ofway that a transit agency maintains is also an asset that can

be used in a joint development scenario

Many different purposes are served by joint

development and one of the issues to be considered by a

transit agency when undertaking joint development is

which policies it wishes to further. The most common

policy is one of increased revenues. Through leasing or

other use of transit property, revenues are sought to be

generated. Another purpose of joint development is

increased ridership. By creating a higher density of

residential or

_____________________________________

7

 In Rider v City of San Diego, 18 Cal 4th 1035, 959 P 2d

347 (Cal 1998), the California Supreme Court upheld a

constitutional challenge to a lease financing and noted the long

history of court cases upholding such financings

commercial areas around a transit facility, joint

development can lead to new ridership or use of the transit

facilities. Another purpose may be to enhance the transit

facility itself. By converting a bare park-and-ride lot to a

transit village with both commercial and residential

facilities, the transit facility is made a more attractive

alternative with added security and conveniences. Whereas

currently revenue generation is the primary focus of transit

agencies in joint development projects, in the future,

enhancement of transit facilities and increased ridership

may take preeminence over revenue considerations.

Legal and Policy Authority for Joint Development

The authority for pursuing joint development is

contained in a mix of congressional legislation, Executive

Orders, and FTA policy initiatives. For example, Section

5309(a)(1)(E) of the Federal Transit Act, as amended,

provided that the Secretary of Transportation may make

grants or loans to assist in financing projects that (i)

enhance the effectiveness of any mass transportation

project and are physically or functionally related to such

mass transportation project or (ii) create or enhance

coordination between mass transportation and other forms

of transportation, either of which enhance urban economic

development or incorporate private investment.8

Grants under the Federal Transit Act can be made for

property acquisition; demolition of existing structures; site

preparation; utilities; building foundations, walkways, and

open space; and the acquisition, construction, and

improvement of facilities and equipment for intermodal

transport facilities and transit malls, but generally may not

be made to finance the construction of commercial

revenue-producing facilities or those portions of public

facilities not related to mass transportation.9 The Federal

Transit Act also permits federal participation in land

acquisition, demolition of existing structures, and site

preparation for mixed use projects.

Additional authority for joint development is

embodied in ISTEA, which encourages more efficient

management and enhancement of public transit

infrastructure through the creation of public/private

partnerships. Joint development also finds support in

Executive Order 12893, "Principles for Federal

Infrastructure Investments," signed by the President on

January 26, 1994. Section 5C of Executive Order 12893

states:

_____________________________________

8

 Federal Transit Act Section 5309 (a)(1), 49 U S.C A 5309

(a)(1)(E), (1997, 1998 Suppl ) By technical amendments made in

the Transportation Equity Act for the 21st Century, Pub L No 105-

178, 112 Stat 107, this language has been moved to 49 U S.C 5302

(a)(1)(G) See Sec 3003 of H.R. 2400 and p 146 of House Conf.

Rpt. 105-550.

9

 Fed Transit Act Sec. 5309 (f), 49 U.S C A. 5309 (f) (1997)

This section was repealed by TEA-21 and these criteria were

placed in 49 U S C 5302 (a)(1)(G) (i) & (ii) See citation in footnote

8
12

Federal agencies shall seek private sector participation in

infrastructure investment and management Innovative

public/private initiatives can bring about greater private

sector participation in the ownership, financing,

construction, and operation of infrastructure programs.

Consistent with the public interest, agencies should

work with state and local entities to minimize legal and

regulatory barriers to private sector participation in the

provision of infrastructure facilities and services

Moreover, the FTA in November 1994 issued its

Livable Communities Initiative, which encourages

userfriendly transit projects that effectively link residents

with local and economic services and jobs. The Livable

Communities Initiative endorses mixed use development

and describes certain characteristics of successful "livable

communities":

Livable Communities involve careful coordination of

transit planning with community development planning

Livable communities are neighborhoods where housing,

schools and parks are within easy walking distance of

user-friendly transit opportunities that effectively link

residents with local social and economic services and

jobs In livable communities, transit service reflects the

diverse needs of the community.

Transit facilities [in Livable Communities] are designed

to include space for day care centers, dry cleaners, and

other enterprises that are useful to transit passengers.

Under the Livable Communities Initiative, the FTA

may provide Section 5309 (formerly Section 3) and Section

5336 (formerly Section 9) capital grants for enhancements

to transit stations; park and ride lots; transfer points

incorporating community service and customer

convenience facilities (such as health care centers, banks,

retail services and the like); safety elements; sidewalks;

skyways; access roadways; and other transit-related

improvements.

The Livable Communities Initiative requires transit

agencies proposing federally-funded projects to

demonstrate that the projects are transit-related and

promote the concept of livable community in the area

adjacent to the project. The FTA requires a local match of

20 percent for all grants under the Livable Communities

Initiative.

Finally, the FTA published its Innovative Financing

Initiative on May 9, 1995,10 which gives explicit support

for joint development using Section 3 and Section 9

funding, as well as funding under the STP and Congestion

Management Air Quality Programs. The Innovative

Financing Initiative announced:

[A]ssets previously acquired with FTA funds may be

used for joint development purposes For example, land

now used for station parking and no longer needed for

transit purposes may be converted to use in a transitrelated development project.. FTA program funds may

be used for the overall planning of a transit-related

project, including the commercial revenue-producing

facilities, so long as such commercial facilities are part

of an overall transit-related project

_____________________________________

10 60 Fed Reg 24681 (May 9, 1995)

Private Use Issues

The FTA's stated policy is to review joint

development proposals on a case-by-case basis.11 It may be

beneficial for a transit agency to use consultants to guide

proposals through the FTA's approval process. The FTA's

subjective approach may arise from the conflict between

the private sector participation inherent in all joint

development and long-standing federal policy that

discourages undue private benefit from public agency

grants.

This policy is evident in the complex and stringent

Internal Revenue Service regulations regarding the private

use of projects financed with proceeds of tax exempt bonds.

Another example of this policy is the general rule that

transit assets funded by federal grants must remain in mass

transit service over the life of the asset. If the asset is

removed from mass transit service during its useful life,

then the prorated, depreciated federal share of the asset

must be rebated to the federal government. This result can

be mitigated, however, by transferring the federal interest

in certain assets to other transit assets, in accordance with

the FTA's guidelines.12

Key Legal Issue: Issues that are raised in joint

development focus on the statutory authority of the agency

to undertake the joint development activity (public bidding

requirements may prohibit the structure); the limitation on

any funding available for joint development, whether it be

state, federal or local; and whether there are any tax law

restrictions on the various funding mechanisms available

for the joint development project.

Case Study--Vertical Mall Joint Development for

Miami-Dade Transit Agency (Dade County, Florida)

The Miami-Dade Transit Agency (MDTA) recently

completed construction on an ambitious joint development

project adjacent to one of its heavy rail transit stations. The

process began over a decade ago, and Miami-Dade's

experience is illustrative of certain issues that can arise

when undertaking a project involving joint development.

The Parties

The Miami-Dade Transit Agency is the transit

operations agency of Miami-Dade County, Florida. MiamiDade serves the greater Miami metropolitan area, operating

approximately 600 buses as well as the 21-mile elevated

rail line known as Metrorail.

The private developers involved in Miami-Dade's

development project were the Green Companies, Jeff

Berkowitz & Co., and Mark Millgram & Co., in a joint

venture.

_____________________________________

11 FEDERAL TRANSIT ADMINISTRATION, INNOVATIVE

FINANCING HANDBOOK (undated)

12 FEDERAL TRANSIT ADMINISTRATION, INNOVATIVE

FINANCING INITIATIVE, 60 Fed. Reg. 24681-84 (May 9, 1995).
13

The Project

The existing site upon which the project was

constructed consisted of a 9.2-acre park-and-ride lot

containing approximately 750 parking spaces, adjacent to

Miami-Dade's heavy rail Dadeland North Station. MiamiDade originally purchased this land with Urban Mass

Transportation Administration (UMTA)13 capital grant

funds. Shortly before construction of the project, the State

of Florida financed the construction of an above-ground

parking structure with approximately 2,000 parking spaces

adjacent to the Dadeland North Site. Phase 1 of the project

itself involved a "vertical mall" containing approximately

315,000 square feet of retail space, at a construction cost of

approximately $40 million. The developers of the vertical

mall entered into a 90-year ground lease with Miami-Dade

for the use of the Dadeland North Site.

The Financing

In 1981, Miami-Dade issued a Request for Proposals

(RFP) for the Lease and Joint Development of the Dade

North Metrorail Station Site. Pursuant to this RFP, MiamiDade selected the Green Companies, and protracted

negotiations followed for approximately 12 years. In 1994,

under the threat of Miami-Dade issuing a new RFP to

developers, the Green Companies, in a joint venture with

Jeff Berkowitz & Co., and Mark Millgram & Co.,

negotiated a revised arrangement with Miami-Dade that

included the following provisions:

1. Minimum rent to be paid to Miami-Dade for the use of

the Dadeland North Site will not be less than $100,000

per year, plus 5 percent of gross revenues from the

operation of the vertical mall Miami-Dade has projected

this 5 percent portion to be approximately $1,500,000,

which will generate an estimated $40,000,000 in

additional revenue for Miami-Dade over the 25-year

lease term

2. If Miami-Dade discontinues transit service to and

from the Dadeland North Station, the parties agree to

review the impact of such termination and make an

equitable adjustment in the lease.

3. Construction plans shall include several "transit

friendly" design features

While Miami-Dade's impasse with the developers was

being resolved, a new hurdle arose-FTA approval. The

federal government retained an interest in the Dadeland

North Site because Miami-Dade's purchase of the land was

financed with an UMTA capital grant. In 1989, UMTA

approved a proposed lease between Miami-Dade and the

Green Companies, but the parties could not agree on certain

major business points. By the time Miami-Dade was able to

reach agreement with the developers in 1994, the FTA

(through its Region IV Office) had disapproved the project.

The FTA's Region IV Office noted that after project

completion, the Dadeland North Site would technically

_____________________________________

13 UMTA or Urban Mass Transportation Administration was the predecessor

to the Federal Transit Administration.

no longer have a transit use. The Region IV Office made it

clear if the project went forward, Miami-Dade would be

expected to buy out the FTA's interest in the property. In

support of their decision, the Region IV Office cited the

provisions of Office of Management and Budget Circular

A-102 (March 3, 1988), which requires the disposition of

UMTA-financed property no longer used for a transit

purpose.

Miami-Dade appealed this decision to FTA

headquarters in Washington, DC. Miami-Dade argued that

a strict interpretation of the OMB Circular would contradict

several policy pronouncements promoting joint

development. Miami-Dade stressed the transit purpose of

the project as a whole and noted that all rental income from

the project would be used only for public transit. Moreover,

Miami-Dade predicted that the project would increase its

ridership by at least 200,000 riders per year. Miami-Dade

ultimately prevailed and on June 28, 1994, the FTA granted

its formal approval of the project.

Case Study--Santa Clara Valley Transportation

Agency--Almaden Lake Village

The Santa Clara Valley Transportation Authority

(VTA), in partnership with the Almaden Lake Village

Associates, is in the process of developing a highdensity

rental community on the Guadalupe Corridor light rail

system's Almaden park-and-ride lot. The building of the

Almaden Lake Village is the first project of its type in the

nation and is targeted at residents who are priced out of the

housing market and/or those who choose the convenience

and amenities of luxury apartment living with easy access

to transit.

The Parties

The VTA is the transit agency for the City of San Jose

and the other 14 cities located in the County of Santa Clara,

which contains the largest population in the San Francisco

Bay area and a thriving manufacturing and services section,

including the famed Silicon Valley concentration of hightech computer firms.

Almaden Lake Village Associates is a limited

liability partnership established by the developer of the

project.

The Project

Almaden Lake Village was completed in 1998. It is

built on 7.1 acres (5.4 acres net) of VTA-owned land at the

Almaden park-and-ride lot at Winfield Boulevard and

Coleman Road in San Jose. The high-density, multiresidential complex includes 250 units, with a density of

47.2 dwelling units per net acre.

The purpose of the Almaden Lake Village Project and

subsequent high-density residential projects is threefold.

First, to allow VTA to generate a continuing revenue

stream in order to defray operating and other expenses;

second, to use high-density residential development in

order to gain as many new riders as
14

possible for the transit system; and third, to enhance the

environment at and around the park-and-ride lots and

provide a sense of "place" and "community" at those

locations

The Almaden Lake Village project is primarily a

market-rate apartment development with 20 percent of the

units available to low-income households. Subsequent

projects could incorporate affordable housing units and,

perhaps, a commercial/retail component into the design.

The project cost $32 million and was built on property

leased from VTA under a 75-year ground lease. The rental

of the land for the project is the direct monetary benefit the

agency receives from this joint development.

The Financing

VTA established a joint development program to

identify and implement joint development opportunities at

VTA-owned park-and-ride lots. The first step in

implementing the program was to assess the benefits of and

opportunities for joint development. Studies conducted

ranked the Almaden light rail park-and-ride lot as the first

most feasible location for a joint development project.

Studies also found that the benefits of joint development

(i.e., revenue production, increase in transit ridership, and

enhancements to the environment around the transit

facility) at this site would come from a high-density

residential development.

VTA has long pursued strategies to increase ridership

and seek out additional revenue sources. The Almaden

Lake Village Joint Development project will help to meet

these objectives. It will supplement fare box revenues and

because of its higher than average densities and direct link

to the station, increased ridership is expected.

Park Place, in Mountain View, a 370-unit project

development by Prometheus featuring three-story buildings

over a podium with subgrade parking, was selected as the

best prototype for the project, since a design of its type

would cost less to build and it commands the highest rents

in Santa Clara County. The architect for Park Place, Fisher

Friedman Associates, was hired to design a project for

Almaden Lake Village modeled after Park Place.

The Almaden Lake Village 250-unit complex has two

and three-story buildings on podiums over subgrade

parking and features fully-secured main grounds and innercourtyards with easy pedestrian access to the Almaden

Transit Station and Guadalupe River Park. An East Block

and a West Block are situated on either side of a connecting

road that provides car and bus traffic with road access. The

existing roadway was moved 100 feet to the west to

accommodate this combined use and maximize the

efficiency of the site.

Additional project amenities include a lap pool and

spa, 3,300-square-feet recreation center with community

lounge, meeting rooms, and a fully-equipped fitness center.

Water features and landscaping are an integral part of the

project.

The developer for the project was chosen by VTA

following a request for proposal process. Financing for the

Almaden Lake Village project is solely the responsibility of

the project developer. VTA's board was firm in not

assuming any risk with respect to the development and not

subsidizing the development other than by providing the

land and agreeing to subordinate the lease payments for the

land to the financing required for the project. The developer

initially sought a loan from the Department of Housing and

Urban Development (HUD), but after a series of delays it

was determined that the HUD loan was too problematic and

the process too lengthy. Tax credits were next analyzed as a

possible means of financing the project, but due to a rules

change, the tax credit route was not considered feasible.

Finally, financing the project through the issuance of tax

exempt bonds as a multifamily housing project, containing

20 percent low-income units, was determined to be the

most advantageous option.

The City of San Jose was instrumental in providing

the bond financing, which requires an allocation of the state

volume cap for private activity bonds. Support of the local

government appears to be a key element in the success of

the joint development project. Local zoning and permits

need to be granted for the project to proceed in a timely

manner. An aggressive campaign of community

involvement and support in the project can be beneficial. It

is possible for community activists to focus on the joint

development project as a means of illiciting more amenities

from the city, such as additional parks and landscaping.

Following the necessary bond approval and cap

allocation from the state, bond financing allowed the

construction to proceed. VTA anticipates receiving

revenues from the project in the form of annual lease

payments, which were set pursuant to a market rate based

on an appraisal of the land. One of the advantages of the

Almaden site was that the land was not purchased with

federal transit funds so FTA approval was not required.

In the future, the VTA may be less risk adverse and

seek to play a more active role in the development. This

may include expanding the type of development to include

commercial facilities as well as housing facilities. Correct

assessment of the feasibility of a proposed joint

development project may require that the VTA obtain

analysis from a neutral third-party (not the developer) with

expertise in the area. The Almaden Lake Village may prove

to be a prototype for future developments of park-and-ride

lots.

Various legal issues were raised in the development of

the joint development project and were addressed by

different counsels, as appropriate. The initial key legal

issue was the legality of choosing a developer for the site

through an RFP process, a modified public bidding process

allowed under state law. This decision as to the legality of

the RFP was made at the agency counsel level. Special

counsel was involved in the financing, as well as attorneys

for the City of San Jose.
15

Case Study--San Francisco Bay Area Rapid Transit

District (BART) Telecommunications System

In 1994 BART solicited RFPs from private developers

interested in installing, maintaining, managing, and

marketing a fiber optic telecommunications system under a

long-term license agreement that would provide revenue

sharing to BART and at the same time meet BART's own

telecommunication needs.

The Parties

BART is a legislatively-established voter approved

transit district covering three counties in the San Francisco

Bay Area. The BART system is a 39-station, 93 mile

regional rail system currently serving approximately 2 9

million people in the three San Francisco Bay Area

counties: Alameda and Contra Costa Counties and the City

and County of San Francisco. The system began passenger

operations in 1972. It is the principal commuting

transportation system for residents of Alameda and Contra

Costa Counties who work in the City and County of San

Francisco, accounting for 57 percent of all transbay, hometo-work trips that terminate in the core part of San

Francisco's central business district The District owns

approximately 650 rail cars, which operate over 93 miles of

double mainline tracks. Twenty-eight of those miles are in

the subway, 24 miles are on an elevated structure, and 43

miles are at grade. An extension south of San Francisco

through San Mateo County to the San Francisco

International Airport is currently being developed. BART

has some unique physical assets in that it has transit lines

that run in the East Bay, a transbay tube that runs under San

Francisco Bay to downtown San Francisco, and a line

running through San Francisco that eventually will extend

to the San Francisco International Airport. This system

provides an asset in the form of a right of way upon which

a fiber optic network may be installed.

The Metropolitan Fiber System Network

Technologies, Inc., (MFSNT) was chosen pursuant to the

RFP process to develop the telecommunications system.

The Project

The MFSNT/BART contract and agreements provide

for the development of a telesystem consisting of a

commercial fiber optic telecommunications system and a

fully integrated BART telecommunications system. A

portion of the conduit system's capacity will be used to

support the BART telecommunications system. The

remaining capacity will be made available by MFSNT for

commercial use, which will generate revenue for BART as

described below. The BART telecommunications system

will replace BART's existing telecommunications system

with a new trunk radio system, a synchronous fiber-opticbased data transmission network, and the hardware and

software to fully integrate the entire system for BART's

use. The BART telecommunications system is a one-of-a

kind system within the transit industry. Other transit

properties have portions

of the proposed improvements, but the BART

telecommunications system is unique.

The BART telecommunications system was financed

pursuant to a lease with MFSNT with principal components

in the amount of approximately $45 million. MFSNT

supplies all of the equipment for and provides engineering

and construction management services to fully integrate the

BART telecommunications system. Construction work

associated with the installation of the BART

telecommunications system (estimated at 10 percent to 20

percent of the cost of the BART telecommunications

system) was competitively bid by BART. In the event that

BART's competitive bid process results in a cost that

exceeds the $45 million, MFSNT agreed to pay the

difference. In the event that BART's competitive bid

process results in a cost that is less than the $45 million,

MFSNT agreed to reduce BART's financial obligation

accordingly. BART entered into a 15-year Equipment

Lease-Purchase contract with MFSNT for the

telecommunications system. MFSNT retains ownership of

the BART telecommunications system for the term of the

contract. At the end of the term, ownership will transfer to

BART. BART has an option to purchase the equipment

during the term of the lease purchase contract.

MFSNT provides the materials for, owns, and operates

the conduit system in BART's right of way for revenue

generation under a 15-year Telecommunications License

Agreement. Installation of the conduit system was

competitively bid. In return, BART shares in the revenue

generated from MFSNT's operation of the portion of the

conduit system that is not required for the BART system.

At the end of the term, ownership will transfer to BART. It

was originally projected that revenues from the commercial

operations would offset most of the cost of the financing

for the BART telecommunications system.

The Financing

In the course of the joint development project with

MFSNT, a number of legal issues had to be addressed.

Among these were the public bidding requirements that

control BART's ability to enter into the contract with

MFSNT. Certain parts of the project, such as installation of

the conduit that contains the fiber optics, were contracted

pursuant to competitive bid. However, the major aspect of

the acquisition of the equipment was accomplished through

the RFP process.

California Public Contract Code Section 20229.1

authorizes the BART Board of Directors to direct the

procurement of certain equipment, including electronic

equipment, by competitive negotiation, upon a finding, by a

two-thirds vote of the BART Board, that the purchase of

equipment in compliance with the provisions of the Public

Contract Code generally applicable to such purchases

would not be adequate for BART's needs. Competitive

bidding of a complex integrated system such as the one

sought by BART did not meet BART's needs, as BART

would be constrained in its ability to
16

evaluate the qualifications of proposers and the technical

merit of the proposals. Furthermore, if competitive bidding

procedures were used for procurement of the system, it

would not be feasible for BART to consider adequately the

revenue sharing offered by bidders or the merits of their

financing packages. The RFP process used by BART to

solicit proposals for the telecommunications system met the

requirements for competitive negotiation.

Another issue that arose was that some of the right of

way owned by BART had been purchased with state

moneys provided by the California Department of

Transportation (Caltrans). Caltrans' consent was therefore

required in order to allow the joint commercial use of the

right of way by MFSNT. In exchange for Caltrans'

permission to allow BART to use such joint right of way

for the revenue generating telecommunications network,

BART agreed to allow Caltrans to use a portion of the fiber

optics cable ability along BART's entire right of way.

BART and Caltrans also agreed to consider revenue sharing

in the future. BART's environmental compliance staff

determined that the project would not have any significant

effect on the environment and, therefore, that the project

and its approval was exempt from the California

Environmental Quality Act.

The joint development project was financed by a lease

purchase agreement of BART under which the BART

telecommunications system was purchased by BART

pursuant to a tax-exempt financing. The financing required

BART to make payments to the lender; however, payment

could be deferred until the project was delivered. Based on

certain projections, it was considered possible that revenues

generated by the commercial use of the fiber optics system

would be sufficient to offset a major portion of the

payments required by BART to finance its own

telecommunications system. BART, however, was taking a

financial risk. If the revenues generated from the

commercial use of the fiber optics system were not

sufficient, BART's own general fund revenues would

supply the funds to pay for the lease purchase financing.

Another legal issue that had to be addressed was

whether the use by MFSNT of the right of way was

prohibited by existing bond covenants of BART as portions

of the right of way had been purchased with taxexempt

bond proceeds. Bond counsel to BART determined that the

use of the right of way by the fiber optic cable was

incidental and would not adversely affect BART's

outstanding tax-exempt bonds. BART has recently

commenced operations of the telecommunications system.

Revenues are just now beginning to be realized from the

use of the system and it is too early at this point to

determine whether sufficient revenues will be generated to

offset the cost of BART's telecommunications system

Lessons Learned from Joint Development

Any joint development project is going to require a

knowledge of state procurement laws or other restrictions

on the use of transit property at the state level, as well as an

understanding of FTA restrictions if FTA funded property

is involved in the joint development. The policy behind

many of these laws is to ensure that private entities do not

benefit from the special use of public property without a

fair selection process or just compensation. Obtaining the

"best price" for a public asset at public bidding is seen as

protection from potentially abusive influence by private

interests. Because of the inherent public/private partnership

in joint development, overcoming the public bidding laws

is one of the more difficult hurdles. In the joint

development projects studied here, the direct economic

benefit to the different transit agencies, typically rent

payments, appears minimal compared to the costs of the

projects undertaken. Nonmonetary benefits such as

economic development, community development, potential

increased ridership, and a free flow of information may

provide other justification for joint development. However,

the potential for uncompensated or undercompensated

exploitation of public assets by private firms that are

unfairly selected is also a concern in any joint development

project.

IV--CROSS-BORDER LEASES OF TRANSIT

VEHICLES

Introduction

Cross-border leasing transactions are designed to

enable a foreign entity to receive in its country the tax

benefits associated with ownership of an item of

equipment. These transactions are attractive to many transit

agencies because the foreign entity, the "lessor" of the

equipment, will pay the 'lessee" (the transit agency)

between approximately 3 percent and 7 percent of the cost

of the equipment for entering into the transaction. These

revenues are then available to the transit agency for any

purpose. The transaction is structured so that, for practical

purposes, it does not materially affect the operations of the

transit agency. These leases do not "finance" the vehicles

being leased; rather, they generate unencumbered revenue

to the transit agency from the foreign tax treatment

associated with ownership of such vehicles. The decision of

the transit agency is whether the revenues are sufficient for

undertaking the risk of the transaction. Certain inherent or

perceived risks of the transaction of concern to potential

lessees can be minimized to acceptable levels by provisions

in the agreement.

The following is intended to identify some of the

common concerns of lessees in cross-border leases and to

indicate how they can be reduced while maintaining a

transaction acceptable to cross-border lessors.

The Structure of a Cross-Border Lease Transaction

Cross-border leases are very generally structured as

follows:

• The foreign entity lessor borrows money from a

bank on a nonrecourse basis;
17

• Next, the entity purchases the equipment either

directly from the transit agency or from the manufacturer

with the proceeds of the loan; and

• Finally, the foreign entity leases the equipment to

the lessee transit agency. As security for the loan, the lessor

assigns to the lender lease payments made by the lessee

transit agency sufficient to repay the loan.

The cross-border lease appears to be a real lease.

Often title is held by the foreign entity and the transit

agency is a lessee. Economically, however, the crossborder lease puts the benefits and burdens of ownership of

the equipment onto the transit agency lessee, not the lessor.

The foregoing structure is intended to place United

States tax and commercial ownership with the lessee.

Because various foreign jurisdictions are more formalistic

in their approach to ownership for tax purposes, tax

ownership under the laws of the lessor's country resides

with the lessor. It is this difference in approach that allows

cross-border leasing to work.

Cross-border leases can be defeased or nondefeased,

depending on the jurisdiction involved and the financing

needs of the lessee:

• In a defeased structure, the lessee will pay to an

entity (usually a bank and frequently an affiliate of the

lender) an amount equal to the amount the lessor borrowed

from the lender. The defeasance bank will then assume

responsibility for payment of all obligations to the lender.

The lender will look only to the defeasance bank for

payment, not the equipment.

• A nondefeased structure is very similar to a

leveraged lease, except that the lessee has United States tax

ownership of the equipment and, subject to the discussion

below, is obligated only to repay the loan (and, if

applicable, the equity investment of the lessor) in order to

terminate all of the lessor's interests in the equipment.

Following are a listing of the key risks to a crossborder transaction and suggested approaches to minimizing

such risks.

Risks To Lessees

The risk: Lease termination triggering stipulated loss

payment obligation. Typically, leases may be terminated

upon a default by the lessee, the destruction of equipment,

or a change in tax laws. These termination events will give

rise to the obligation of the lessee to make stipulated loss

payments to the lessor.

Minimizing the risks:

Lessee Defaults--The obvious method of reducing the

risks of default by the lessee is to reduce the lessee's

obligations. Depending upon the degree to which the

lessor's jurisdiction requires the lease to resemble a "true"

lease for the lessor to receive tax benefits, it may be

possible to draft the documents so that the lessee's

obligations regarding insurance, maintenance, and taxes are

the same as the lessee performs normally for similar

equipment. In a defeased lease, the risk that a lessee will

default in its lease payment obligation can

be virtually eliminated through financial arrangements with

the defeasance bank.

Destruction of Equipment--In a defeased transaction,

destruction of an item of equipment harms the lessee and

the lessor. The lessee must make a stipulated loss payment

and the lessor loses the tax benefits associated with

ownership of the equipment. The standards for determining

whether an item of equipment has been destroyed should,

therefore, be no more onerous than the applicable tax law

definition of a casualty.

The risks to the parties arising upon destruction of the

equipment can be further reduced if the lessor and lender

will allow substitution of equipment.

Stipulated Loss Payment--The stipulated loss payment

is always at least equal to the loan amount. In a defeased

structure this amount is paid by the defeasance bank. In

both a defeased and nondefeased transaction, the stipulated

loss payment also includes an additional payment to the

lessor. The exact amount of this payment will vary

depending upon the circumstances giving rise to the

termination, the period when the termination occurs, the

bargaining strength of the parties, and the practices under

the jurisdiction where the lessor is located.

The risk: Lessor bankruptcy. Bankruptcy of the lessor

raises the risk that the bankruptcy trustee will treat the lease

as a real lease and take control of the equipment for the

benefit of the lessor's bankruptcy estate.

Minimizing the risks:

Reduce Bankruptcy Risk.--Lessor bankruptcy risk can

be reduced by using a special purpose corporation or

similar entity with a low bankruptcy risk. Additionally,

most lessors are part of substantial organizations that have

the tax appetite to allow them to receive the foreign tax

benefits associated with cross-border transactions. It may,

therefore, be possible to reduce the bankruptcy risk through

a guaranty or other assurance from the lessor's parent

organization.

Lease Termination--It may be possible for the

bankruptcy of the lessor to give the lessee the right to

terminate the lease. Upon such a termination, the stipulated

loss schedule should require only a payment sufficient to

repay the lender and the amount of the equity invested in

the transaction. If the lease is defeased, this payment is

made by the defeasance bank and no additional payment is

made to the lessor. This forced sale by the lessor to the

lessee, however, may not be enforceable against the lessor's

bankruptcy trustee.

Structural provisions can be added to improve the

enforceability of this forced sale. However, the availability

and enforceability of each such device will vary depending

upon the lessor's jurisdiction.

Lessee Has Title--Regardless of whether any of the

foregoing are effective to cause the lessor (or its

bankruptcy trustee) to reconvey title to the lessee, it may be

possible to conclude, based upon the overall transaction,

that for United States commercial law purposes, the lessee

owns the equipment. If the equipment is in
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the lessee's possession in the United States and the lessee

performs its obligations under the lease, then it will

probably be very difficult for the lessor's bankruptcy trustee

to obtain possession of the equipment.

The risk: Defeasance bank bankruptcy

Unless the defeasance structure is a legal defeasance

(in which the lessee is completely released from any of the

obligations assumed by the defeasance bank), the lessee

will be liable for the payments under the lease assumed by

the defeasance bank if the defeasance bank does not pay.

Minimizing the risks:

Reduce Bankruptcy Risk--Most banks selected to act

as defeasance banks are very highly rated; therefore, as a

practical matter, the bankruptcy risk is quite low. However,

because cross-border leases frequently have terms in excess

of 15 years, a high credit rating may not be sufficient

comfort.

Setoff Protection--Defeasance bank bankruptcy risk

can be further reduced through a setoff arrangement. The

lease will provide that it can be terminated upon a

defeasance bank bankruptcy and that the lessee can assume

the lessor's position under the loan in lieu of making the

stipulated loss payment. Therefore, on a defeasance bank

bankruptcy, after assuming the loan, the lessee may be able

to set-off against the loan obligation the obligation the

defeasance bank owes to the lessee under the agreement by

which the defeasance bank assumed the obligation to pay

the lease payments.

The risk: Retaining tax ownership. On its surface, the

transaction is characterized as a sale and leaseback of the

equipment. The lessee faces the risk that it will be forced to

accept the form of the transaction for transfer and property

tax purposes. If the lessee is forced to accept the form of

the transaction, it may be exposed to transfer taxes (such as

sales or use taxes) and local property tax exemptions may

be lost. The lessee typically indemnifies the lessor against

these risks. If the transaction is really in substance a loan or

a sale of tax benefits, then these taxes can be avoided.

Minimizing the risks:

Place the Benefits and Burdens of Ownership on the

Lessee--To ensure that the lease is characterized as a loan

or a sale of tax benefits rather than a saleleaseback, it must

be possible to conclude that during the lease term the

benefits and burdens of ownership are retained by the

lessee and in all events the lessee will own the equipment at

the end of the lease term. In a cross-border lease the lessee

essentially has all of the rights and responsibilities of

ownership. Ensuring that the lessee will own the equipment

at the end of the lease term is frequently accomplished

through put and call provisions in the lease documents.

These provisions require that the lessor and the lessee make

economically irrational decisions in order for the lessee to

not obtain title to the equipment at the end of the lease

term. Lessees may want to obtain an opinion from their

tax counsel or a ruling from the local tax authorities to be

assured of the consequences of the transaction

Avoid Inconsistent United States Tax Positions With

Lessor--The Internal Revenue Service is concerned about

parties to a transaction taking inconsistent positions to the

detriment of the United States government. To avoid this

whipsaw risk, the lessor should agree with the lessee not to

attempt to claim United States state or federal tax

ownership of the equipment.

The risk: United States withholding tax. Cross-border

lessees will generally indemnify lessors for United States

tax law risks. This includes the risk that the payments to the

lessor will be subject to a United States withholding tax.

Minimizing the risks:

Tax Treaties--Many of the countries with lessors most

frequently involved in cross-border leasing (including

Sweden, Germany, and France) have tax treaties with the

United States that reduce the withholding rate on lease

payments to zero. Japan's tax treaty reduces the rate to 10

percent. Even if these treaties are amended or abrogated, it

should be possible to insert into the lease provisions that

would allow the lessee to treat the lease payments as

interest payments and avail itself of the statutory portfolio

interest exemption.

Burdensome Buyout--To reduce the risk to the lessee

of a change in the tax treaties, the lessor should be willing

to allow the lessee to terminate the lease upon such an

event by payment to the lessor of an amount that will fully

compensate the lessor for the termination of the transaction.

Legal Defeasance--If the transaction is legally

defeased, then the lessee can take the position that there are

no payments being made by it to the lessor on which it

must withhold.

The risk: Local tax consequences. The lessee will

generally have responsibility for United States local tax law

risks such as income tax, sales/use tax, and property tax.

Minimizing the risks:

Income Tax--State income tax rules generally follow

the federal treatment of a transaction.

Sales/Use and Property Tax--Sales/use and property

tax authorities are generally more formalistic on ownership

questions and particular care must be taken in transactions

involving property that has already been placed in service.

The risk: Foreign tax consequences. Lessees are

justifiably unwilling to assume foreign tax law risks in the

transaction due to their unfamiliarity with those laws.

Minimizing the risks:

Limited Liability--Lessors should generally be willing

to assume the risk for changes in laws in their own

jurisdiction. One way to accomplish this is to not give the

lessor the right to terminate the lease upon a change of law

in the lessor's country. In a defeased transaction, this also

can be accomplished by allowing
19

the lessee to terminate the lease without any payments

other than the defeased payments to the lender

Case Study--Regional Transportation District (Denver,

Colorado) Cross-Border Lease

On December 22, 1994, the Regional Transportation

District of Denver, Colorado (RTD), successfully closed a

cross-border lease transaction with DB Export Leasing

GmbH (DBX), involving 11 light rail vehicles.

The Parties

RTD is a political subdivision of the State of

Colorado, authorized to develop, maintain, and operate a

mass transportation system for the benefit of inhabitants of

the district. RTD's boundaries generally encompass the

greater Denver metropolitan area.

DBX, a wholly-owned subsidiary of Deutsche Bank

AG, was the Lessor in this transaction.

CS First Boston (Nederland) N.V. (CSFB) acted as

Accounts Receivable Purchaser for the transaction. As

Accounts Receivable Purchaser, CSFB was essentially

acting in the capacity of lender.

The Project

The property encumbered by this cross-border lease

consisted of 11 light rail vehicles manufactured by Siemens

Duewag Corporation. The equipment had a useful life of 20

years and an appraised value at closing of approximately

$25 million. RTD's net benefit from the transaction

amounted to approximately 2 percent of the value of the

equipment.

The Financing

The first step in this transaction was RTD's sale of the

equipment to DBX This sale was accompanied by an

acknowledgment from Siemens Duewag Corporation, the

equipment manufacturer, that despite the sale it would not

seek compensation from DBX for claims or disputes

relating to the equipment.

This transaction was structured as a leveraged lease,

with DBX financing approximately 84.3 percent of the

purchase price of the equipment. This financing did not

consist of a bank loan. Instead, DBX entered into an

Accounts Receivable Purchase Agreement with CSFB.

Pursuant to this agreement, DBX sold to CSFB without

recourse certain accounts receivable consisting of basic rent

to be received by DBX under the Lease Agreement,

stipulated loss value, and other amounts recoverable by

DBX under the Lease Agreement. From CSFB's standpoint,

this structure was superior to a conventional loan.

Generally, lenders in leveraged lease transactions

ultimately look to the lessee for repayment and treat the

lessor as largely a pass-through entity. CSFB has a more

direct creditor relationship with RTD as the holder of

accounts receivable payable by RTD than as a lender to

DBX, with the loan collateralized by a security interest in

lease payments payable by RTD. This

structure was possible because, under German tax law, this

arrangement is viewed as a loan from CSFB to DBX, and

the accounts receivable sale proceeds are not considered to

be current income of DBX.

RTD then leased the equipment from DBX under the

Lease Agreement, which grants RTD a purchase option at

the end of its 18-year term. With the proceeds from the sale

of the equipment, RTD paid its transactions costs, prepaid

its lease obligations, and funded an escrow account to

finance the purchase price of the equipment on the

purchase option date, retaining approximately 2 percent of

the proceeds as its net benefit from the transaction. The

prepayment of lease payments is accomplished pursuant to

an Assumption Agreement between RTD and CSFB. Under

the Assumption Agreement, RTD paid an up-front sum to

CSFB in consideration for CSFB's agreement to pay certain

Specified Payments, which are defined to include basic rent

and stipulated loss value under the Lease Agreement. By

virtue of entering into the Accounts Receivable Purchase

Agreement and the Assumption Agreement, CSFB became

essentially both the obligor and the obligee on the same

obligation.

The Lease Agreement was economically defeased by

the Assumption Agreement, but RTD retained certain

contingent liabilities, including payment of the purchase

option price. Although RTD was not required to do so,

RTD chose to defease this liability by depositing U.S.

Treasury securities in an escrow account held by Colorado

National Bank, which will have a maturity value at the end

of the Lease term not less than the purchase option price.

RTD's tax indemnities to DBX represented another

contingent liability. RTD was especially concerned about

withholding taxes and German Value Added Taxes.

Typically, lessees mitigate this indemnity risk with a

burdensome buyout option. DBX would not agree to any

provisions for a burdensome buyout, however, because the

concept was not compatible with the analysis of German

tax counsel. Ultimately, DBX chose to accept this risk and

proceed with the transaction. At the time, another crossborder lease between DBX and the San Diego Metropolitan

Transit Development Board was moving on a parallel track,

with most of the same parties and substantially identical

documentation. That transaction did not close, largely

because of the absence of a burdensome buyout option.

Case Study--San Diego Metropolitan Transit

Development Board Cross-Border Lease Financing

In November 1995, the San Diego Metropolitan

Transit Development Board (MTDB) entered into a crossborder lease financing in connection with the acquisition of

97 buses.

The Parties

The parties to the transaction were MTDB, as lessee,

JL Coronado Lease Co., Ltd., as lessor, and the Dai-Ichi
20
21

Kangyo Bank, Ltd., New York Branch, as lender. The

lessor in this situation was a corporation formed under the

laws of Japan and the transaction was referred to as a

Japanese leveraged lease.

The Financing

The arrangers prepared a summary of terms for the

Japanese leverage lease, and this term sheet was negotiated

among the parties. Upon agreement of the terms, the

necessary documentation was prepared. This

documentation included a Participation Agreement among

the lessee, the lessor, the lender, and the lender's agent that

set forth the general agreement and understandings between

the parties; a Lease Agreement pursuant to which the lessor

leases the buses to the lessee; a Loan Agreement between

the lender and the lessor pursuant to which the lender

agrees to loan to the lessor 73 percent of the costs of the

acquisition price for the buses (the remaining costs are

supplied by the equity deposit of the lessor); and various

custodian and security interest agreements, including an

interest exchange agreement, deposit agreement, debt

funding agreement, deposit pledge agreement, and security

agreement.

The lessor, pursuant to an assignment of the purchase

agreement, received legal title to the buses and paid the

purchase price of the buses to the vendor. The lessee then

leased the buses from the lessor. One of the issues that had

to be addressed by the parties was the ability to have title to

the vehicle expressed in the name of the lessor and a valid

security interest or lien on such vehicle given to the lender.

The appraised value of the vehicles is an important

ingredient in structuring the transaction, providing a basis

for the security that the lessor gives for repayment of the

loan to the lender. A valid appraisal is one of the items

required to be submitted at the closing. Another item

required to be delivered at closing is FTA approval of the

financing.14

In the documents the lessee transit agency is required

to make certain representations. Among them is the

representation that the defense of sovereign immunity is not

available to the transit agency with respect to obligations

under the lease. This is a representation that may vary

depending on the laws of the jurisdiction of the lessee

Other heavily negotiated provisions of the documents are

the tax indemnifications and the events of termination, all

of which pertain to the relative risk sharing of the parties to

the transaction.

_____________________________________

14 FTA review is concerned with the level of fees paid to

facilitate a cross border lease vs the net present value benefit to the

transit agency In reviewing fees, the FTA seeks to ensure that total

fees paid are less than the expected net present value benefit to the

transit agency FTA policy guidance for transit agencies

considering cross border leasing of federally funded equipment is

contained in FTA Circular C7020 1

Innovative Nature of the Financing

MTDB had participated in prior cross-border lease

financings. What made this transaction unique was

MTDB's economic defeasance of its lease obligation.

Defeasance of MTDB's lease obligation was not required in

this transaction. However, in order to minimize the risk of

the financing to the lessee transit agency, MTDB desired to

economically defease its lease obligation. The original term

sheet for the proposed financing had specified that

defeasance would be accomplished through the purchase of

B-rated variable rate corporate bonds by MTDB. Concern

over the legal authority for such an investment and a desire

to have a more secure, higher rated investment caused

MTDB to request its financial advisor to propose another

method by which the defeasance of its lease obligation

could be accomplished.

Asset Swap for Defeasance

MTDB chose an asset swap to defease its obligations

under the cross-border lease. The provider of or

"counterparty" to the asset swap was National Westminster

Bank Plc, acting through its New York Branch (NatWest).

The asset swap used a standardized International Swap

Dealer Association, Inc., (ISDA) master agreement for a

multi-currency cross-border swap. The obligation of

MTDB under its cross-border lease consisted of a set

principal repayment schedule with a variable 6-month

LIBOR rate plus 30 basis points. By the asset swap, MTDB

made an up-front payment derived from the lender portion

of its cross-border lease. This payment of approximately

$18.5 million contributed to the purchase of the assets to be

held pursuant to the asset swap. The assets consisted of

certain taxable municipal securities. These taxable

municipal securities had ratings of AA or better and had

principal and interest payments on a fixed basis. By

entering into the swap, MTDB agreed to pay to NatWest

the upfront payment ($18.5 million), principal and interest

payments corresponding to the principal, interest payments

on the underlying assets (the "Muni Bonds") and, upon

conclusion of the swap, the proceeds from the sale of the

Muni Bonds. In exchange NatWest, the swap party, made

principal and interest payments equal to MTDB's obligation

under its cross-border lease financing, that is the designated

principal payments plus interest on the principal at the 6-

month LIBOR rate plus 30 basis points. Through the swap,

MTDB eliminated the risk of being able to invest the $18.5

million at a rate sufficient to pay a 6-month LIBOR rate

plus 30 basis points. MTDB eliminated that variable rate

risk and assumed the risk of the underlying credit on the

Muni Bonds. This credit rating (AAA to a great extent) was

much higher than the B-rated corporate bonds originally

proposed for the defeasance. In addition, MTDB assumed

risk associated with NatWest's credit strength or continued

liability, as NatWest was its counterparty in the swap

transaction. This risk in a swap is commonly referred to as

"counterparty risk."
22

Although the lease defeasance asset swap that MTDB

availed itself of to defease its cross-border lease was a

unique instrument, transit agencies' use of the swap market

can be very advantageous. The difficulty of taking

advantage is the requirement that one have assets of a

sufficient material value, such as the $18.5 million in

MTDB's case study, to invest. In addition to eliminating the

variable rate investment risk by accomplishing the lease

defeasance asset swap, MTDB was able to alleviate the

administrative burden of monitoring and tracking the

investment of the sum involved. As transit agencies face

continued economic pressures, a smaller staff is required to

perform at the utmost level of efficiency. Freeing up

administrative staff time for other purposes was an

additional beneficial side effect to the defeasance.

V--U.S. LEASEHOLD INTEREST

In recent years there has been increasing interest

among exempt entities in a leasing transaction commonly

known as "leasehold interest" transactions. The transactions

must comply with federal tax laws and regulations. The

Internal Revenue Service released Revenue Ruling 99-14

on March 11, 1999, 26 C.F.R. 1.162-11, which may curtail,

if not eliminate, the tax benefits to the equity investor in

these transactions. If successfully completed, the transit

agency can realize a benefit ranging from 4 percent to 10

percent or more of the value of the leased asset. This

chapter describes the basics of the leasehold structure and

sets out a checklist of issues to determine the feasibility of

such a transaction.

The Structure of U.S. Leasehold Interest Transactions

In a typical leasehold structure for a U.S. lease:

• The transit agency as the owner of equipment or

facilities (the "head lessor") leases the equipment or

facilities (the "asset") to a trustee for the benefit of a U.S.

Equity Investor (the "head lessee"). This lease is called the

"head lease,"

• The head lessee then leases the asset back to the

transit agency (the "sublessee"). This lease is called the

"sublease,"

• The head lessee prepays the rent under the head

lease in one or more installments. A substantial portion of

the funds needed to make the prepayments is borrowed

from a lender, and the balance represents the head lessee's

equity investment in the transaction;

• The equity portion and the debt portion are repaid

through sublessee payments under the sublease. Repayment

of the equity portion is economically defeased through the

purchase of U.S. Treasury securities to be held by the head

lessee, and repayment of the debt portion is economically

defeased through a deposit with an affiliate of the lender

(the "payment undertaker");

• The difference between the amounts paid to the

head lessor under the head lease and the sum of the equity

defeasance and the debt defeasance represents

the net benefit to the head lessor from the transaction; and

• At the end of the term of the sublease, the sublessee

has an option to purchase the asset at a fixed price. Please

see the attached charts for schematic diagrams of the

leasehold structure and cash flows.

Key Legal Issues: The following issues must be

addressed to determine the feasibility of the leasehold

structure.

Is the owner of the asset:

• a nontaxpayer (e.g., U.S., state, or local

governmental authority)?

• at least A-rated or willing and able to provide letters

of credit from banks rated AA or better?

Does the asset have:

• a 20-year minimum remaining life?

• a minimum $50 million value?

• a fair market value, taking inflation into account,

that increases or at least remains stable for at least 20

years?

Is the asset property that the head lessee could

reasonably use or lease to a party unrelated to the asset

owner? (i.e., leasing the asset back to the transit agency

cannot be the head lessee's only commercially feasible use

of the asset).

Does the existing financing of the asset include:

• a security interest in the asset? If so, the existing

financing must be prepayable or capable of being

incorporated into the leasehold structure.

• tax-exempt bonds? If so, it must be determined if

the leasehold interest will cause the bonds to be taxable.

Do the existing contracts directly or indirectly transfer

the value of the asset to another party?

The asset must have value to the owner. Otherwise the

value of the leasehold interest will be small or minimal,

eliminating the benefit of the transaction. Such a transfer of

value might occur under an exclusive operating contract

based upon a pass-through of all costs, with no profit

potential.

Are there contractual or bond covenant restrictions on

the head lessor's right to lease or sell the asset? Does local

law restrict transfers and leasing or pledge of assets or

require a public bid, voter approval, and other similar

requirements?

The transit agency must have the legal power and

authority to lease the asset to the head lessee and to lease

the asset from the head lessee.

The transit agency must have the legal ability to

pledge assets to satisfy the security provisions of the

structure, including the ability to grant security interest in

the asset and in the deposits or payments of the payment

undertaker, as well as the ability to indemnify the debt and

equity participants in the transaction.

Each transaction is tailored to the needs of the equity

investor to some extent and is not amenable to bid.
23
24
25
26

Public bidding requirements may prohibit the necessary

negotiated nature of the transaction.

The transit agency must have authority to make the

purchase of the defeasance securities and to enter into the

payment undertaking.

Can the deal be structured around local use, sales, and

property taxes? Who bears the broken deal risks? If there

are changes in the tax law, such as if the Section 467

regulations are finalized, the leasehold transaction may not

be doable. If the transaction fails to close, the transit agency

could be required to pay substantial transaction costs.

Substantial additional property tax issues are presented if

the property involved is real property

Selected Indicative Issues

Payment Undertaker Risk-Typically, the structure of

the transaction contemplates having the debt defeasance

entity (the "payment undertaker") make the sublease

payments owed by the transit agency through the entire

term of the sublease. Any bankruptcy or other financial

difficulty affecting the payment undertaker could trigger an

event of default under the sublease with severe

consequences for the transit agency. In order to mitigate

this risk, only the most creditworthy entities are selected as

payment undertakers. In addition, if the long-term senior

debt obligations of the payment undertaker cease to be

rated at least AA- by Standard & Poor's Ratings Services or

Aa3 by Moody's Investors Service, the parties agreement

typically contains provisions that call for the parties to the

transaction to negotiate in good faith to select a new

payment undertaker, in order to refinance the obligations of

the former payment undertaker, and adjust the rent

payments, default payments, and purchase option prices

due under the sublease. Such refinance rights are not

always available, depending upon the assumptions,

analysis, and tax law framework.

Event of Loss-In order to attempt to mitigate the

impact of an event of loss, the transit agency may elect not

to include one or more of its rail cars in the transaction.

Since the leases permit, under certain conditions, the

substitution of leased equipment, holding such property in

reserve potentially acts as an insurance policy against the

payment of stipulated loss value and other unwind costs in

the event any equipment is destroyed during the lease term.

On the other hand, the transit agency also has to forgo the

net benefit of including the additional rail cars in the

transaction.

Every U S. leasehold interest transaction involves

assumptions of certain risks by the transit agency These

risks can be minimized by structural and drafting

technique, but not eliminated. The transit agency must

determine that the risks are acceptable when balanced

against the economic benefit.

Case Studies

Although many of the major transit providers in the

United States have successfully closed U.S. leasehold

transactions, the agencies we contacted declined to be

examined as case studies out of deference to their investors.

VI--FARE BOX REVENUE BONDS

Introduction

The following chapter addresses fare box revenue

bonds. Fare box revenue bonds involve the issuance of debt

by a transit agency, which is secured by a pledge of the

revenues collected by operation of the transit system. Fare

box revenue bonds are rare due to the simple fact that most

transit systems operate at substantial deficits. Transit riders

on average pay less than 40 percent of transit operating

costs. Federal, state, and local subsidies are necessary to

maintain operations.

The Structure of a Fare Box Revenue Transaction

For a traditional revenue bond, such as one for a water

or sewer system, an issuer covenants to charge rates that

will produce revenues sufficient to cover operating and

maintenance costs and debt service. Such a covenant is

called a "rate covenant." A "coverage factor" is also

commonly desired in which the issuer will covenant to

maintain revenues in excess of operations and maintenance

expenses by a certain multiple of the annual debt service

owed on its outstanding obligations. Factors of 1 10, 1.25,

1.5, or 2 times the coverage have all been used to seek

investment grade ratings on revenue debt.

Transit systems are different:

• Because a transit system does not produce sufficient

net fare box revenues to cover debt service, a gross revenue

pledge is employed. A gross revenue pledge measures

gross revenues to debt service and requires substantial

coverage (3 or 4 times debt service).

• To evaluate the potential transaction, the viability of

the system is analyzed to determine how creditworthy it is.

The essentiality of the system to the local economy may be

more important to a credit analysis than an impractical rate

covenant. It will not be desirable to require an increase in

rates by way of a rate covenant if the result of such increase

is less riders and ultimately less revenues. What percentage

of total commute trips are provided by the transit system?

Rate increases may also lead to less public and

political support for subsidy payments What is the elasticity

of the demand for the transit service? What are the

alternatives to the transit system and the relative cost of the

alternatives?

Large metropolitan systems with well developed

routes and consistent ridership levels are most appropriate

for fare box revenue borrowing. Even with such a transit

system, other dedicated subsidy sources such as sales taxes

or bridge tolls may be essential in order to obtain an

investment grade rating on debt.
27

Key Legal Issue: Are fare box revenues sufficient

security for a financing and does the transit agency have

authority to issue fare box revenue bonds? The first part of

this issue is a credit determination ultimately made by the

ability to sell the bonds in the capital markets. The latter

legal issue is governed by state law.

Case Study--New York Metropolitan Transportation

Authority Transit Facility Revenue Bonds, Series 1998C

In December 1998, the Metropolitan Transportation

Authority issued $317.245 million in principal amount of

its Transit Facilities Revenue Bonds, Series 1998C. There

are $2.282 billion aggregate principal amount of transit

facility bonds of the Authority outstanding including the

series 1998C Bonds.

The Parties

The Metropolitan Transportation Authority, a

public benefit corporation of the State of New York, has

responsibility for developing and implementing a unified

mass transportation policy for The City of New York and

Dutchess, Nassau, Orange, Putnam, Rockland, Suffolk, and

Westchester counties (collectively with the city, the

"Transportation District"). The Authority carries out these

responsibilities directly and through its subsidiaries and

affiliates, including the New York City Transit Authority,

an affiliate of the Authority, and the Manhattan and Bronx

Surface Transit Operating Authority (MaBSTOA), a

subsidiary of the Transit Authority

The Project

The city's rapid transit system is by far the largest in

the nation. Only a few cities in the world have a subway

system comparable in physical size and ridership. The

subway system has over 656 miles of mainline track

extending 230 route miles. It operates 24 hours a day, 365

days a year. In calendar year 1998, approximately 1.2

billion revenue passengers used the subway. The Transit

Authority employs approximately 25,000 workers in rapid

transit. It currently has a fleet of approximately 5,800

subway cars, two major subway car repair shops, 14

maintenance shops, 23 subway car storage yards, and 468

passenger stations.

The Transit Authority and MaBSTOA presently

operate bus service on approximately 230 local and express

routes throughout the city. The majority of bus routes are

designed to serve passengers traveling within a particular

borough or to serve as feeders to the subway system. In

calendar year 1998, approximately 625.5 million revenue

passengers used the bus system. Together, this bus system

employs approximately 13,000 persons and operates

approximately 4,100 buses.

To assist the Transit Authority and MaBSTOA in

carrying out its role, the Authority has been authorized to

issue bonds, payable from certain revenues and operating

subsidies of the Transit Authority and MaBSTOA,

to fund a portion of the capital needs of the Transit

Authority and MaBSTOA. The Series 1998C Bonds were

issued by the Authority to refund other bonds issued for

such purpose.

The Financing

The Series 1998C Bonds are special obligations of the

Authority payable solely from and secured by a pledge of

the items pledged under the Transit Facilities Special

Obligation Resolution of the Authority, adopted October

14, 1982, as supplemented. These include the Revenue

Fund into which there is to be deposited, pursuant to an

agreement among the Authority, the Transit Authority, and

MaBSTOA, dated July 1, 1982, as authorized by Title 9 of

Article 5 of the Public Authorities Law, as amended (the

Transit Authority Act), fares collected for use of the

subway and bus systems operated by the Transit Authority

and MaBSTOA, payments from concessionaires, and

operating subsidies (not including federal operating

subsidies). The operating subsidies include expense

reimbursement payments from the State of New York, the

city, and the Triborough Bridge and Tunnel Authority

(TBTA), an affiliate of the Authority. The operating

revenues and subsidies pledged under the Resolution are

collectively referred to as the "pledged revenues" or

"revenues."

The Series 1998C Bonds are on a parity as to the lien

on pledged revenues with all bonds that are, and with all

bonds and parity obligations that from time to time may be,

issued and outstanding under the Resolution.

The financing agreement obligates the Transit

Authority and MaBSTOA to fix or adjust the rates of fares,

fees, rentals, and other charges for the use of the system at

the level required by the Resolution, which obligates the

Authority to cause the Transit Authority and MaBSTOA to

adjust such rates as necessary to produce revenues, together

with other lawfully available moneys, sufficient to pay debt

service on bonds and parity obligations, maintain all debt

service reserve funds at their required levels, and pay all

operating and maintenance expenses and other obligations

of the Transit Authority and MaBSTOA as they become

due. This covenant is similar to a traditional revenue bond

rate covenant with the added feature of including subsidy

payments and other available revenues. Due to the lack of

control the Authority has over the amounts of subsidies and

other revenues, such amounts would not have been

included in a traditional revenue debt analysis.

The Transit Authority and MaBSTOA have

covenanted in the financing agreement that prior to the

commencement of each fiscal year the Transit Authority

and MaBSTOA will prepare inspection, maintenance, and

repair programs and revise such programs, if necessary, in

order to procure an Independent Engineer's Certificate

stating that such programs are reasonable and appropriate.

Such a certificate has been furnished for each fiscal year

required. The Transit Authority and MaBSTOA have also

covenanted to include
28

the cost of such programs in their annual operating budgets

and, on or before the commencement of each fiscal year or

60 days following the receipt of the Independent Engineer's

Certificate, whichever comes later, to fix or adjust fares or

other charges required to generate revenues during the

fiscal year sufficient, together with all other lawfully

available moneys, to pay the debt service on bonds and

parity obligations, operating and maintenance expenses

included in such budgets, and all other obligations to

become payable during the fiscal year.

The financing agreement further provides that if the

actions by the Transit Authority and MaBSTOA to meet

their obligations under the financing agreement are not

sufficient to allow the Authority to meet its obligations to

make payments to holders of bonds and parity obligations

and to make all required deposits under the Resolution, the

Transit Authority and MaBSTOA shall, and the Authority

and the Trustee may, take such actions to require the

Transit Authority and MaBSTOA to fix or adjust the rate or

rates of fares, fees, rentals or other charges for the use of

the system as shall be necessary to produce revenues that,

together with all other lawfully available moneys, shall

enable the Transit Authority and MaBSTOA to make the

payments required under the financing agreement.

Additional bonds (other than refunding bonds) and

parity obligations may be issued only if, in addition to

other requirements, the Authority meets certain tests

established under the Resolution, including the delivery of

a certificate of an Independent Engineer stating that it is

feasible that revenues can be derived from the operations of

the system so that certain coverage ratios can be

maintained during the current and each of the succeeding 3

fiscal years. The Independent Engineer's certificate must

also state that certain historical revenues, adjusted on a pro

forma basis as provided in the Resolution, provide four

times coverage for adjusted aggregate maximum debt

service.

Under the Authority's enabling legislation, the state

pledges to and agrees with the holders of any notes, bonds,

or lease obligations issued or incurred by the Authority,

including bonds and parity obligations, that the state will

not limit or alter the rights vested in the Authority to fulfill

the terms of any agreements made by the Authority with

the holders of its notes, bonds, and lease obligations,

including bonds and parity obligations, or in any way

impair the rights and remedies of such holders. The

Authority's enabling legislation also prohibits the

Authority from filing a petition in bankruptcy under

Chapter 9 of the Federal Bankruptcy Code or such

successor chapters or sections as may from time to time be

in effect. The state has pledged that so long as any notes,

bonds, or lease obligations of the Authority are

outstanding, it will not limit or alter the denial of authority

to the Authority to so file. Similar covenants apply to the

Transit Authority and MaBSTOA.

The pledged revenues of the Transit Authority and

MaBSTOA are receipts derived from a number of

sources that may be grouped into seven principal

categories: (i) fares; (ii) income from concessions and

advertising; (iii) fare and service reimbursements from the

city for certain costs incurred by the Transit Authority and

MaBSTOA; (iv) operating subsidies provided by the state

and the city from their general funds; (v) amounts derived

from special tax-supported operating subsidies; (vi)

amounts derived from TBTA's operating surplus; and (vii)

income from investments and miscellaneous other sources.

Pledged revenues amounted to approximately $3.36

billion in 1998 (representing 21 times aggregate bond

service for such year). Revenues derived from fares

charged to users of the system in 1995 aggregated

approximately $2.0 billion, or approximately 68 percent of

operating disbursements.

The rate or rates of fares charged to users of the

system are determined by the Transit Authority and

MaBSTOA after reviewing and adopting operating expense

budgets. After assessing the availability of governmental

subsidies, the Transit Authority and MaBSTOA make a

determination of the level of fares needed to operate on a

self-sustaining cash basis. Due to the impact of fares on

users of the system and on the regional economy, it is the

policy of the Transit Authority and MaBSTOA to attempt

to reduce costs or obtain additional revenues from other

sources prior to increasing fares. Consequently, the amount

and timing of fare increases are affected by the federal,

state, and city financial conditions and budgetary and

legislative processes.

The Authority relies on a mixture of federal, state, and

local subsidies; TBTA operating surpluses; and dedicated

special taxes to make up the operating deficit and fund

capital costs. There is an inherent tension between the

desires of the credit markets for a secure revenue bond with

customary rate covenant and coverage and the reality of

transit operations, which is one of providing a public

service that, while in part is userbased through fee

collections, is also subsidized as part of the Transportation

District's infrastructure.

The Authority employs a rate covenant but adds to the

fare box revenues other available revenue, including

subsidies to determine compliance with the rate covenant.

The Authority has a coverage test for the issuance of

additional debt, but it is a gross coverage test of certain

revenues at four times debt service. Therefore, the

Authority's fare box revenue bonds have the trappings of

traditional revenue bonds, but not the substance. A

traditional revenue bond would require net revenues

sufficient to cover debt service. Due to the subsidy

required for Transit Authority and MaBSTOA operations,

there are no net revenues from operations. The inability to

declare bankruptcy is very unique and of great reassurance

to investors in the deficit-prone operations. Investors have

the assurance that operations will continue and the

Authority's debt cannot be avoided.

There is no assurance that there is any level at which

system fares would produce revenues sufficient to comply
29

with the rate covenant of the financing agreement in the

event the level of collection of dedicated taxes, operating

subsidies, and expense reimbursements presently provided

for the system were to be discontinued or substantially

reduced. As is generally the case with publicly operated

mass transit systems in the United States, the system has

been dependent upon aid and assistance to meet its capital

and operating needs in the past, and it is anticipated that

the system will continue to be so dependent for a

substantial portion of such needs in the future.

Fare box revenue is not sufficient (and is never

anticipated to be sufficient) to maintain operations and

cover debt service and capital costs. The Transit Authority

and MaBSTOA are dependent on governmental subsidies

that can get mired in the legislative process (a delay in

adopting the state budget can result in a delay in receiving

certain subsidy payments and cash flow restraints), or vary

depending on appropriations. In New York, where the

transit system is vital to the economy and of a sufficient

size to weather recession years and a downturn in ridership,

a revenue based financing is deemed creditworthy. If the

system was not as integrated into the Transportation

District infrastructure or if it did not have the historical and

institutionalized financial support that the Authority

enjoys, its access to the credit markets would most likely

be more limited.

The Authority as an issuer is unique in more than just

the technique it uses to finance capital improvements.

Having a system that generates approximately $1.9 billion

a year in operating revenues and has a fare box recovery

ratio of approximately 68 percent is unique. In addition to

the Authority's issuance of transit fare box bonds, the

Authority has issued dedicated tax fund bonds secured by

certain state subsidies. TBTA has issued general purpose

revenue bonds secured by TBTA bridge and tunnel tolls,

special obligation bonds secured by regional mortgage

recording taxes and by TBTA net revenues on a

subordinate basis, and beneficial interest certificates

secured on a subordinate basis on TBTA net revenues. In

1982 and 1987 the state agreed to permit the Authority to

issue service contract bonds secured by the state's

appropriation of debt service to finance Transit Authority

and MaBSTOA capital needs. Being vital to a region,

having a long historical existence in the infrastructure, and

possessing accepted financial subsidies (such as the TBTA

bridge and tunnel tolls) completes the unique nature of the

Authority's financing alternatives.

Case Study--$169.5 Million Los Angeles County

Metropolitan Transportation Authority General

Revenue Bonds (Union Station Gateway Project) Series

1995-A

On January 19, 1995, the Los Angeles County

Metropolitan Transportation Authority issued $169.5

million in principal amount of its General Revenue Bonds

(Union Station Gateway Project) Series 1995-A. At the

time, the Authority had nearly $2.2 billion of long-term

sales tax revenue bonds outstanding, but this was its first

experience with bonds secured by fare box revenues.

The Parties

The Los Angeles County Metropolitan

Transportation Authority is a public agency created by

the California Public Utilities Code with the responsibility

for planning, financing, constructing, and operating the

rapid transit system of Los Angeles County. The Authority

provides bus service throughout the County of Los

Angeles, as well as portions of neighboring Orange and

Ventura Counties. In addition, the Authority operates a

light rail system and a subway service within Los Angeles

County. The Authority was formed in 1993 upon the

merger of the former Los Angeles County Transportation

Commission and the former Southern California Rapid

Transit District.

The Project

After the merger of the Authority's predecessor

agencies in 1993, the need for centralized office space

became acute. A study undertaken by the Authority

indicated that annual debt service on a tax-exempt

financing to construct a new headquarters building would

be less than the total annual occupancy costs, including rent

and operating expenses, that the Authority would be

incurring if it continued to occupy its current premises.

The Authority's new headquarters building, known as

the Union Station Gateway Headquarters Building, is a 26-

story office building designed to accommodate 1,900

employees. The Headquarters Building includes over

628,000 gross square feet of office space and

approximately 800 parking spaces. It is located in the

northeast portion of downtown Los Angeles, near Amtrak's

Union Station depot. The Headquarters Building and

adjacent public transit improvements to be constructed are

expected to serve as a transportation hub for the region,

connecting passengers of commuter rail, subway, light rail,

bus, and Amtrak service.

The total cost of the Headquarters Building was

approximately $145.5 million. Construction began in

February 1993, approximately 2 years prior to the issuance

of the bonds. The Authority financed a portion of this

construction with $98 million of sales tax revenue

commercial paper, which was retired with bond proceeds.

The Authority took occupancy of the Headquarters

Building in September 1995.

The Financing

The bonds are special, limited obligations of the

Authority, payable from and secured by a prior lien on

"pledged revenues" and "remaining sales tax." Pledged

revenues are generally defined as all fare box revenues and

advertising revenues, together with interest income thereon,

derived from the facilities and properties maintained and

operated by the Authority. Remaining
30

sales tax is generally defined as the net proceeds of the

Authority's transportation sales tax levied in Los Angeles

County, after the payment of debt service on obligations

secured by such sales tax revenues on a basis senior to the

bonds. If pledged revenues are insufficient to pay debt

service on the bonds when due, the Authority has agreed to

make such payments from any moneys available to it for

use for any lawful purpose, including but not limited to

remaining sales tax and the Authority's share of certain

state and local transportation subsidies.

At the time the bonds were issued, the Authority's net

available fare box revenues for the most recently ended

fiscal year (1993-94) totaled approximately $207.703

million, with over 96.6 percent of that amount generated by

the Authority's bus service. Remaining sales tax for the

1993-94 fiscal year amounted to approximately $439.886

million. At the same time, the Authority was facing a

budget deficit of approximately $126 million

The bonds were structured as multi-mode variable rate

securities, insured by Financial Security Assurance, Inc.

The bonds were initially issued in a weekly interest rate

mode, with liquidity support provided by a 3-year Standby

Bond Purchase Agreement with Societe Generale. Due to

this credit enhancement and liquidity support, the bonds

were rated "Aaa/VMIG-1" and "AAA/A-1+" by Moody's

Investors Service and Standard & Poor's, respectively. The

Bonds received a SPUR (S&P Underlying Rating) of "A-",

reflecting Standard & Poor's assessment of the Authority's

stand-alone ability to pay debt service on the bonds.

To hedge a portion of its variable rate exposure, the

Authority entered into interest rate swap agreements with

Goldman Sachs Capital Markets, L.P., (GSCM) and

GBDP, L.P., (an affiliate of Grigsby Brandford & Co.

{GBDP)). The GSCM swap had a notional amount equal to

75 percent of the principal amount of the bonds and paid

the Authority the actual interest rate borne by the bonds in

exchange for the Authority's fixed payments. The GBDP

swap had a notional amount equal to 25 percent of the

bonds' principal amount, and paid the Authority a floating

amount based on the PSA Municipal Swap Index. Both

interest rate swap agreements were scheduled to terminate

in 10 years; the remaining 20-year term of the bonds was

unhedged. The Authority expected this partial synthetic

fixed rate structure to achieve a lower overall cost of

borrowing than the issuance of the bonds as fixed rate

obligations.

At the time this transaction was being structured, the

Authority was planning and constructing an ambitious and

comprehensive rail rapid transit system for Los Angeles

County. The capital needs for this system were being

financed with a combination of federal and state grants and

the proceeds of two countywide sales taxes levied for

transit purposes. These sales taxes secured nearly $2.2

billion of the Authority's sales tax revenues bonds.

The Authority made a policy decision not to finance

construction of the Headquarters Building with sales

tax revenue bonds, in order to preserve financing capacity

for planned rail improvements. The Authority's fare box

revenues provided the best alternative security for the new

financing and were the historical source for payment of

office space leases.

Various aspects of the bonds, including sources of

repayment and coverage tests for additional parity bonds,

were formulated after lengthy discussions with the

members of the Authority's financing team, the bond

insurer, and, in particular, the rating agencies. A significant

source of the Authority's nonoperating revenues consisted

of state and federal grants, which by their terms could not

be pledged to pay debt service or were too unpredictable to

be included in the revenue pledge. Thus, FTA Section 9

funds are not part of the security for the bonds, and the

Authority's state and local transportation subsidies are not

pledged, but only made available to pay debt service to the

extent pledged revenues are insufficient. Remaining sales

tax is pledged to the payment of the bonds, but such

revenues are not deposited with the bond trustee on a

monthly basis, as is the case with the Authority's fare box

and advertising revenues.

The Authority was willing to provide additional

security for the bonds by granting a first mortgage on the

Headquarters Building. The bond insurer ultimately

rejected this collateral because of perceived difficulties in

foreclosing against a governmental entity and the limited

utility of such security in light of California's "one form of

action" rule.

An important goal was to structure the Trust

Agreement for the bonds like an enterprise revenue bond

indenture, with the flexibility to issue additional series of

parity and subordinate bonds secured by the same revenue

sources. This would allow the Authority to exploit the

maximum bonding capacity of its general revenues at the

lowest overall cost.

Standing in the way of this goal was the fact that the

Authority's transportation system was not a traditional

"enterprise" in several key respects. Like most transit

agencies, the Authority has never attempted to set bus and

rail fares at levels high enough to cover the cost of

providing the service-in fact, the Authority's operating

deficit for the 1994-95 fiscal year exceeded half a billion

dollars. This deficit was covered by federal and state transit

subsidies and local sales taxes. Moreover, considering the

MTA's operating deficit, elasticity of demand concerns, and

potential political and legal considerations, the customary

rate covenant found in most enterprise revenue bond

indentures was determined to be inappropriate.

On the other hand, the Authority's fare box revenues

had been fairly stable over the past several years. While the

Authority's structural operating deficits would preclude a

net revenue pledge, a gross pledge could still be

worthwhile. Finally, the Authority's historical receipts of

sales tax revenues, as well as federal, state, and local grants

and subsidies (aggregating over $364.295 million in the

1994-95 fiscal year), suggested
31

that its transit operations would remain financially viable.

Ultimately, the structure, provisions, and general tenor

of the Trust Agreement for the bonds reflected a hybrid of

concepts from both enterprise revenue and unsecured

financings. There was a gross pledge of fare box and

advertising revenues, but no rate covenant. The Trust

Agreement established various debt service accounts with

different priorities, but the coverage ratio for additional

parity bonds called for pledged revenues and remaining

sales tax to be at least equal to 300 percent of maximum

annual debt service. This unusually stringent test reflects

the fact that transit revenues are volatile and not directly

subject to the Authority's control. In this respect, the rating

agencies and bond insurers appeared to view the bonds as

somewhat less secured than general fund lease obligations,

where acceptable "coverage" (to the extent the concept is

applicable) for an investment grade stand-alone issue may

indicate a general revenues to debt service ratio of 5 to 1,

10 to 1, or greater.

Postscript

After construction of the Headquarters Building was

completed, the Authority reorganized certain executive

positions and had a change in personnel. Subsequently, the

new management consensus was that the remaining 20

years of variable rate exposure on the bonds was no longer

a prudent risk. On August 20, 1996, the Authority issued

$185.735 million in aggregate principal amount of its

General Revenue Refunding Bonds (Union Station

Gateway Project) Series 1996-A to refund the bonds and

terminate the related swap agreements. The refunding

bonds were issued as fixed rate obligations, again insured

by Financial Security Assurance The Authority has not

issued any additional General Revenue Bonds, but this

borrowing capacity remains available as a financing source

for future special projects.

VII--STATE REVOLVING LOAN FUNDS/STATE

INFRASTRUCTURE BANKS

Introduction

This chapter will address State Revolving Loan

Funds."15 In response to states' requests for greater

flexibility in transportation financing, Congress established

a Pilot Program for State Infrastructure Banks (SIBs)

through Section 350 of the National Highway System

Designation Act of 1995 (NHS Act).16 Section 350

authorized DOT to enter into cooperative agreements with

up to 10 states for the establishment of SIBs or multistate

infrastructure banks for making loans and providing other

assistance to public and private entities carrying out or

proposing to carry out

_____________________________________

15 No case studies are available for this innovation due to its

recent introduction.

16 Pub L No 104-59, § 350, (Nov 28, 1995) 109 Stat 618

projects eligible for assistance under the Section. The

purpose of the Pilot Program was to help DOT proceed

with the concept while simultaneously advancing projects.

Of the 10 originally approved projects, nine signed

agreements with FTA and FHWA.

Under provisions of the Appropriations Act of 1997

for the Department of Transportation,17 DOT was

authorized to enter into agreements with "more than 10

States." Under the NHS and Appropriations Act provisions,

39 states were approved by DOT for SIBs. Four of those

states did not have enabling legislation that would allow

the establishment of the banks, but 34 states have programs

that are in some status of implementation.

The Transportation Equity Act for the 21st Century18

(TEA-21) made several changes in the State Infrastructure

Bank Pilot Program. Most significantly, Section 1151

(b)(1) of TEA-2119 reduced the number of states that could

enter into agreements with DOT to four specific states:

California, Florida, Missouri, and Rhode Island. Other

states, where SIBs were already established, may continue

to operate those banks but there will be no additional

federal funds under current law. Theoretically, since the

banks operate with revolving loan funds, they could

continue indefinitely. Further, the states may add funds

from other sources.

Other changes made by TEA-21 allow the states

greater flexibility in the amount of their federal highway or

transit funds they may contribute to the SIB, rather than the

10 percent limit under the NHS Act. Further, TEA-21

provides that "second generation" payments or repayments

from nonfederal sources be "considered to be Federal

funds" and the requirements of Titles 23 and 49 of the U.S.

Code shall apply to these repayments.20 The NHS Act had

no similar provision.

The Structure of a State Infrastructure Bank

Transaction

An SIB is an infrastructure investment fund

established to facilitate and encourage investment in

eligible transportation infrastructure projects sponsored by

public and/or private entities. Through an SIB, a state can

use its initial capital, provided by its federal-aid highway

apportionment, federal transit allocations, and nonfederal

monies to make loans, provide credit enhancement, serve

as a capital reserve for bond or debt financing, subsidize

interest rates, issue letters of credit, finance purchase and

lease agreements, provide debt financing security, or

provide other forms of financial assistance for construction

of projects qualified under the federal-aid highway

program and transit capital projects.

The revolving loan fund allows pooled vehicle

purchases that may help reduce acquisition costs. In

addition, it provides a mechanism for states to make loans

_____________________________________

17 Pub. L No. 104-205, (Sept 30, 1996) 110 Stat 2959

18 Pub L 105-178, (June 9, 1998), 112 Stat. 107

19 Pub. L No. 105-178, Sec. 1511(b)(1), 112 Stat 251

20 Pub L No 105-178, Sec. 1151(I)(2), 112 Stat. 254.
32

(with interest) or leases to transit operators who might not

be able to finance transactions on their own. Because the

interest and lease payments returned to a state's fund are

considered "program income" they need not be returned to

the U.S. Treasury. The SIB can make new financial

assistance available to other eligible projects, continually

recycling the initial monies, thus leveraging the initial

funds available. Local grantees can use subsequent years'

rural or urban grant funds to make loan or lease payments,

including reasonable interest.

The SIB was expressly designed to provide states with

new levels of financial flexibility to advance needed

projects. There are numerous potential approaches to

implementing an SIB under the Pilot Program. The chosen

approach in each case will be influenced by state laws, the

desire to employ capital markets for additional financing,

the type of financial assistance the state seeks to provide

the projects, the needs of the individual projects to be

financed, and a variety of other factors. While we did not

include a case study for this source of financing, transit

agencies in states where they have been authorized or

established under prior legislation should explore the

potential offered by these programs.

VIII--CONCLUSION

From these case studies we can observe that

innovative financing techniques can be utilized to bring

additional revenues to a transit agency, accelerate the

receipt of transit assets, or expand on a transit agency's

contribution to the community. Certain steps are common

to all the techniques:

Legal authority: Determination of state and federal

legal authority or legal prohibitions on the proposed

financing technique is the first job that a lawyer faces.

Many of the techniques are document intensive,

requiring sophisticated analysis and strategies to minimize

the risks involved in the transaction and to maximize the

gain to the transit agency.

Risk Benefit Analysis: Every financing technique,

whether it be novel, complicated, or customary, contains

inherent risks that must be evaluated by the decision

makers of the transit agency prior to proceeding with the

financing. Legal advisors may be crucial in identifying the

risks, describing appropriate ways to minimize the risks,

and clarifying the options available to the transit agency.

It is important to have realistic goals in determining

whether to proceed with an innovative financing technique.

Such goals are not a lawyer's responsibility, but rather

belong to the policy makers of the transit agency. Often the

economic gains to be derived from a financing are

dependent upon a number of future circumstances that are

beyond the control of the agency. Other policy goals may

benefit from or provide support for the innovative financing

technique, such as low income housing, economic

development, or acceleration of transit service delivery.

Having a clear understanding of the policy makers' goals

for the transaction assists those in structuring the deal to

best achieve those goals.

The techniques described here are not ones that can be

found in FTA regulations or case decisions. They are the

product of transit officials with vision and innovative staff

who have developed these transactions. This is appropriate

in the public arena where the expenditure of public funds is

involved. Most transit agencies are risk adverse and the

undertaking of these innovative financings was done with

careful consideration and an eye to minimizing the risks

involved to the agency and its funds. Although glowing

results are not always possible, the techniques can be

refined, and the benefits that are available from these

techniques may be obtained, where appropriate, in the

transit community.
33

SAMPLE STATE INFRASTRUCTURE BANK/STATE REVOLVING LOAN FUND STRUCTURE

*

Source of chart, Innovative Financing Handbook

Federal Transit Administration
34

APPENDIX A--LISTING OF AGENCIES INVOLVED IN CASE STUDY TRANSACTIONS

1. Sacramento Regional Transit District $32.44 million

California Transit Finance Corporation Certificates of

Participation, 1992, Series A

The Sacramento Regional Transit District

1400 29th Street

Sacramento, CA 95812-2110

Mark Gilbert, Chief Legal Counsel, 916-321-2973; Fax:

916-321-2975

2. $9.66 Million California Transit Finance Corporation

Certificates of Participation, 1996 Series A (City of

Culver City, California)

City of Culver City

9815 Jefferson Boulevard

Culver City, CA 90232

David R. Ashcroft, Transportation Director,

310- 2535851; Fax: 310-253-6513

9770 Culver Blvd

City Hall, 3rd Floor

Culver City, CA 90232

Carol Schwab, City Attorney,

310-253-5560; Fax: 310253-5664

3. Vertical Mall Joint Development for Metro-Dade

Transit Agency (Dade County, Florida)

Miami-Dade Transit Agency

Miami-Dada Center

111 N.W. First Street, Suite 910

Miami, FL 33128-1999

Frank Talleda, Chief Joint Development & Leasing,

305-375-3013

Robert Cuevas, Assistant County Attorney, 305-3755151

4. Santa Clara Valley Transportation Agency--Almaden

Lake Village

Santa Clara County Transportation Agency

3331 North First Street, Building B

San Jose, CA 95134-1906

James R. Lightbody, Manager

Planning & Development, 408-321-5550; Fax: 408-

3217547

3331 North First Street, Building C

San Jose, CA 95134-1906

Suzanne Gifford, General Counsel, 408-321-5744; Fax:

408-321-9765

Almaden Lake Village Associates

5. San Francisco Bay Area Rapid Transit District

(BART) Telecommunications System

San Francisco Bay Area Rapid Transit

P.O. Box 12688

Oakland, CA 94604-2688

Scott Schroeder, Director of Finance, 510-464-6070

Sherwood Wakeman, General Counsel, 510-464-6010

6. Regional Transportation District (Denver, Colorado)

Cross-Border Lease

Regional Transportation District

1600 Blake Street

Denver, CO 80202

Salley Zack Wheller, Senior Manager-Human Resources,

303-299-2206; Fax: 303-299-2015

7. San Diego Metropolitan Transit Development Board

Cross-Border Lease Financing

San Diego Metropolitan Transit Development Board

1255 Imperial Avenue, Suite 1000

San Diego, CA 92101-7490

Renee Wasmund, Director of Finance, (619) 557-4531

Jack Limber, Deputy General Manager & Legal Counsel,

619-557-4512

8. New York Metropolitan Transportation Authority

Transit Facility Revenue Bonds, Series 1998C

New York Metropolitan Transportation Authority

347 Madison Avenue

New York, NY 10017

Kenneth C. Lind, Deputy General Counsel for Public

Finance

212-878-7350; Fax: 212-878-1240

9. $169.5 Million Los Angeles County Metropolitan

Transportation Authority General Revenue Bonds

(Union Station Gateway Project) Series 1995-A.

Los Angeles County Metropolitan Transportation Authority

One Gateway Plaza

Los Angeles, CA 90012-2932

Michael J. Smith, Debt Manager, (213) 922-4042; Fax:

(213) 922-4027

Joyce Chang, 213-922-2502; Fax: 213-922-2531
35

APPENDIX B--INNOVATIVE FINANCING TECHNIQUES--TRNSPORTATION RESEARCH BOARD QUESTIONNAIRE/RESULTS
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ACKNOWLEDGMENTS

This study was performed under the overall guidance of TCRP Project Committee J-5. The Committee is chaired by

RICHARD J. BACIGALUPO, N.E. Illinois Regional Transit Authority. Members are ARTHUR P. BERG, Port Authority of

New York and New Jersey; RICHARD W. BOWER, California Department of Transportation; SHELLY R. BROWN, Federal

Transit Administration-Region 10; DORVAL RONALD CARTER, JR., Federal Transit Administration--Region 5; PAUL

STEPHEN DEMPSEY, University of Denver; DENNIS C. GARDNER, Ogletree, Deakins, Nash, Smoak & Stewart, Houston,

Texas; EDWARD J. GILL, JR., Eckert, Seamans, Cherin & Mellott; BRIGID HYNES-CHERIN, BHC Trans, Arlington,

Virginia; CLARK JORDAN-HOLMES of Stewart, Joyner, Jordan-Holmes, Holmes, P.A.; and JEANETTE J. CLARK,

Washington Metropolitan Transit Authority. NANCY ZACZEK provided liaison with the Federal Transit Administration during

the preparation of this study, and GWEN CHISHOLM SMITH represents the TCRP staff.

TRANSPORTATION RESEARCH BOARD

National Research Council

2101 Constitution Avenue, N.W

Washington, DC 20418